November 1992
A. E. Ext. 92-20
.....
~
FARM INCOME TAX
MANAGEMENT
AND
REPORTING
Reference Manual
George L. Casler
Stuart F. Smith
Department of i\gricultural Economics
College of i\griculture and Life Sciences
Cornell University, Ithaca, New York 14853-7801
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It is the policy of Cornell University actively to support equality
of educational and employment opportunity. No person shall
be denied admission to any educational program or activity or
be denied employment on the basis of any legally prohibited
discrimination involving, but not limited to, such factors as race,
color, creed, religion. national or ethnic origin, sex, age or
handicap. The University is committed to the maintenance of
affirmative action programs which will assure the continuation
of such equality of opportunity.
TABLE OF CONTENTS
Page
TAX LEGISLATION AND THE FARM INCOME SITUATION
1
FEDERAL TAX PROVISIONS AFFECTING INDIVIDUALS
2
CONSERVATION EASEMENTS AND DEVELOPMENT RIGHTS
12
PROVISIONS APPLYING PRIMARILY TO BUSINESS ACTIVITY
13
COMPLETING FORM 1065, SCHEDULES L, M-1 AND M-2
17
PROVISIONS SPECIFIC TO AGRICULTURE
18
DEPRECIATION AND COST RECOVERy
20
REVIEW OF UNIFORM CAPITALIZATION RULES FOR FARMERS
28
CASUALTY LOSSES, GAINS, AND INVOLUNTARY CONVERSIONS
29
GENERAL BUSINESS CREDIT
30
LIKE-KIND EXCHANGES
32
A REVIEW OF FARM BUSINESS PROPERTY SALES
34
INSTALLMENT SALES
38
ALTERNATIVE MINIMUM TAX
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41
NET OPERATING LOSSES
44
PASSIVE ACTIVITY LOSSES
49
INFORMATIONAL RETURNS
51
THE SOCIAL SECURITY TAX SITUATION AND MANAGEMENT OPPORTUNITIES
52
NEW YORK STATE INCOME TAX
56
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1992 TAX FORMS NEEDED BY NEW YORK FARMERS
1040
­
1040EZ ­
1040A ­
1040X
943
1099's ­
1096
W-2
­
W-5
­
W-9
­
­
­
­
1065
­
3800
4136
4562
­
­
­
­
4684
4797
­
­
4835
­
6251
6252
8606
­
­
8582
­
8582-CR­
8615
­
8645
8801
8824
8829
­
­
­
­
New York State Forms
IT-201
- Resident Income Tax Return (long form)
IT-201ATT
Summary of Other Credits and Taxes
IT-201X
Amended Resident Income Tax Return (only acceptable method)
IT-204
Partnership Return
IT-212
Investment Credit (recapture or early disposition schedule included)
IT-220
Minimum Income Tax
IT-399
New York State Depreciation (with instructions)
IT-2102 & IT-2103 - Wage and Tax Statement, and Reconciliation Form
IT-2102.1 & IT-2102.4 - Informational Return and Transmittal Form
CT-4-S
- Short Form for S Corporations
TAX LEGISLATION AND THE FARM INCOME.SITUATION
Proposed Legislation
The Revenue Bill of 1992 was passed by Congress but had not been signed by
President Bush at the time this was written. In addition to several new provi­
sions, this bill extended the following provisions that expired as of June 30,
1992: employer-provided educational assistance and group legal services plans;
targeted jobs credit; energy credit; low income housing credit; research credit and
allocation of expenditures; the health insurance deduction for self-employed; the
special drug deduction; and qualified mortgage and small issue bonds. These provi- .
sions are now in limbo unless and until legislation extending them is made law.
The 1992 bill contained many new provisions related to enterprise zones; full
deductibility of lRAs; modification of passive loss rules on real estate; a tax
credit for first-time home buyers; discharge of indebtedness; a special 15 percent
first-year depreciation; recovery period of 40 years for nonresidential real
estate; limits on moving expense deductions; making in-kind payments to agricul­
tural employees subject to FICA tax and income tax withholding; earned income
credit simplification; elimination of AMT on gifts of appreciated property; simpli­
fied pension distribution rules and about 40 other pension provisions; and many
other items.
1992 Legislation Signed
The Unemployment Compensation Amendments (Bill) of 1992 signed into law on
July 3, 1992 is the only new law containing tax legislation passed in 1992. The
tax provisions of this bill include changes in corporate estimated taxes, modifica­
tion of pension rollover rules, and extension of personal exemption phaseout.
Higher Dairy Farm Incomes in 1992
Farm milk prices averaged $12.49 per cwt. over the first half of 1992, $1.57
above the January through June 1991 average. Monthly milk prices have dropped
since September and will average $13.20 (est.) per cwt. over the last six months,
only $0.57 above the last six months of 1991. Total 1992 milk receipts could be up
8 percent or more per farm depending upon changes in milk production. Changes in
1992 operating expenses will vary from farm to farm but may be up less than 3
percent on the average. 1992 net dairy farm profits will be substantially higher
than in 1991 on well-managed dairy farms.
In contrast, many crop farmers are suffering through a very poor production
and harvest year. Net operating losses will not be uncommon on cash crop and
vegetable farms.
Tax Management Strategies
Estimate 1992 taxable income before the end of the year so receipts and
expenses can be managed to reduce an unexpected, large tax liability, or increase a
small AGI to use up deductions and exemptions. If projected AGI is very low or
negative, there may be an advantage to increasing the loss by delaying sales and
shifting expenses into 1992 if substantial taxes were paid in the last three years.
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FEDERAL TAX PROVISIONS AFFECTING INDIVIDUALS
Standard Deduction
The standard deduction is indexed to inflation and is adjusted annually. The
1992 standard deduction is 5.0 to 5.9 percent higher than the 1991 standard
deduction. The inflationary adjustment was 4.6 percent in 1991 and may drop to 3.1
percent or less for 1993. Look for a joint standard deduction of $6,200 for 1993.
Basic Federal Standard Deduction for 1991 and 1992
Filing Status
Married filing jointly; or qualifying widow(er)
Head of household
Single individuals
Married filing separately
1991
1992
$5,700
5,000
3,400
2,850
$6,000
5,250
3,600
3,000
A married taxpayer filing a separate return is not allowed to use the stan­
dard deduction if his or her spouse claims itemized deductions.
Each taxpayer over age 65 or blind receives the regular standard deduction plus
an additional $700 deduction if married and filing a joint or separate return. The
additional deduction is $900 if single or head of household. These deductions are
up $50 from 1991. The additional deductions are subject to the inflationary
adjustment. A taxpayer who is both elderly and blind receives double the
additional deduction. The additional deductions for age and blindness cannot be
claimed for dependents. The following table provides common examples.
Federal Standard Deductions for Elderly and Blind Taxpayers, 1992
Status
a. Married taxpayers filing jointly,
both 65 or older
b. Status a plus one spouse is blind
c. Married filing separately, age 65
d. Head of household, age 65
e. Single, age 65 or over
f. Single, age 65 and blind
Basic
Deduction
$6,000
6,000
3,000
5,250
3,600
3,600
Additional
Deduction
$1,400
2,100
700
900
900
1,800
Total Standard
Deduction
$7,400
8,100
3,700
6,150
4,500
5,400
Personal Exemption
The 1992 personal exemption is $2,300, up 7 percent from $2,150 in 1991.
projected to be $2,400 in 1993.
It is
Taxpayers are entitled to claim one exemption each for themselves, their
spouses, and their dependents on their federal return. Taxpayers may not claim an
exemption for themselves or any other person who can be claimed as a dependent on
someone else's tax return.
The benefit of the personal exemption is phased out for taxpayers with the
following specific high levels of adjusted gross income:
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$157,900 if married filing jointly or qualifying widow(er) with
dependent child;
$131,550 if head of household;
$105,250 if single
$ 78,950 if married filing separately.
The reduction is 2 percent of the exemption amount for each $2,500 increment (or
any fraction thereof) by which AGI exceeds the appropriate high or threshold
amount. A married taxpayer filing separately will lose 2 percent of his or her
exemption for each $1,250 increment above $78,950.
The personal exemption phaseout or reduction is calculated on an eight-line
worksheet included in 1040 instructions before claiming the personal exemption
deduction on line 36 of Form 1040.
EXample: Mr. and Mrs. P. Grower file jointly, have two children, and their
1992 AGI is $197,000. They claim four personal exemptions. Their reduction and
net exemption are calculated as follows:
AGI $197,000 - $157,900 threshold - $39,100 excess. $39,100 excess +
$2,500 - 15.6 or 16 excess increments. Their reduction is 16 x .02 (2
percent) - .32 x $9,200 (4 @ $2,300) - $2,944. Their net personal
exemption is $9,200 - 2,944 - $6,256.
Dependents
Taxpayers must report the social security numbers of all dependents one year
old or older by the end of the tax year. The penalty for failure to report this
information is $50. Apply for a social security number by filing Form SS-5 with
the Social Security Administration.
Taxpayers may not claim an exemption for a dependent who has gross income of
$2,300 or more unless it is for their child under age 19 or a full-time student
child under age 24 at the end of the tax year. Nontaxable social security benefits
and earnings from sheltered workshops are excluded. A full-time student must be
enrolled in and attend a qualified school during some part of each of five calendar
months. Individuals who can be claimed as dependents on another taxpayer's return
may not claim a personal exemption on their own return.
A qualified child, student or other qualified dependent's basic standard
deduction is limited to the greater of $600 or the individual's earned income up to
his or her standard deduction. The $600 rule limits the basic standard deduction
but not additional deductions for blind and elderly taxpayers. Therefore, a blind
dependent parent, age 65 or older with no earned income and more than $600 of 1992
unearned income, will receive a standard deduction of $2,400 ($600 + $1,800).
Investment or unearned income in excess of $1,200 received by a dependent child
under age 14 is taxed at the parent's marginal rate if greater than the income tax
using the child rates. A three-step procedure is required to compute the tax on
Form 8615 unless an election is made to claim the child's unearned income on the
parent's return where the excess over $1,200 will be taxed at the parent's marginal
rate and unearned income greater than $600 but less than $1;200 will be taxed at 15
percent. This election cannot be made if the child has income other than interest
and dividends or if estimated tax payments were made in the child's name:
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1992 Tax Rates
The three basic taxable income brackets at IS, 28 and 31 percent have been
adjusted for inflation again this year. Each bracket has been moved up
approximately 5.3 percent from 1991, which results in some taxpayers with constant
taxable incomes paying less income taxes in 1992. The phaseout of personal
exemptions for higher income taxpayers is now calculated during the process of
determining taxable income.
1992 Tax Rate Schedules
Single Taxpayers
Taxable
Income
Tax
$0-$21,450
$21,450-51,900
$51,900 & over
15%
$3,217.50 + 28% over
$21,450
$11,743.50 + 31% over
$51,900
Head of Household
Taxable
Income
$0-$28,750
$28,750-74,150
$74,150 & over
Tax
15%
$4,312.50 + 28% over
$28,750
$17,024.50 + 31% over
$74,150
Married Filing Joint Return
& Surviving Spouses
Taxable
Income
Tax
$0-$35,800
$35,800-86,500
$86,500 & over
15%
$5,370 + 28% over
$35,800
$19,566 + 31% over
$86,500
Married Filing Separate Returns
Taxable
Income
Tax
$0-$17,900
$17,900-43,250
$43,250 & over
15%
$2,685 + 28% over
$17,900
$9,783 + 31% over
$43,250
The rates for heads of household are more favorable than those for single
taxpayers and married taxpayers filing separate returns. Single taxpayers who are
maintaining a home for themselves and a dependent should qualify. Married
taxpayers not living in the same household for the last six months of the year are
treated as unmarried and may qualify as heads of household.
Joint vs. Separate Returns
Most married taxpayers save taxes by combining unequal taxable incomes and
using the larger brackets on the joint return. Other benefits available to joint
filers and not available on separate returns are: the child and dependent care
credit, Social security benefits are protected with a higher threshold, and the
alternative minimum tax exemption can be more effective.
However, married couples with two incomes who itemize deductions should
consider filing separate returns. They may be able to save tax dollars because the
7 1/2 percent floor on medical deductions, the 2 percent floor on miscellaneous
deductions and the 10 percent floor on casualty losses could be less on two
individual incomes than on one joint income. Tax savings are most likely to occur
when income is evenly split and one spouse can claim the majority of a deduction
that is limited by percentage of AGI. Other factors favoring separate returns are:
pre-divorce alimony may not be deducted on the joint return; more unreimbursed
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5
employee expenses and investment expenses may be deducted on the separate return
(misc. deductions subject to 2 percent floor); married couples may not be claimed
as dependents by another taxpayer if they file a joint return unless they are below
the gross income filing requirements. Another potential disadvantage of the joint
return is the imposition of joint and several liability on both spouses (i.e., the
spouse is liable for back taxes, interest and IRS penalties resulting from
incorrect joint returns).
Itemized Deductions
A taxpayer should itemize if total itemized deductions are greater than his or
her standard deduction.
Home mortgage interest (qualified residence interest) on the taxpayer's
principal and second home is an itemized deduction providing the mortgage does not
exceed the following limitations:
1. $1 million ($500,000 if married filing separate return) to buy, build or
remodel a home reduced by home mortgage outstanding before October 14, 1987.
This is called "acquisition indebtedness". Interest on home mortgages acquired
prior to this date is deductible.
2. The lesser of $100,000 ($50,000 if married filing a separate return) or the
fair market value minus the acquisition indebtedness qualifies for home equity
indebtedness. Home equity indebtedness may be used for personal expenditures.
Mortgage interest that exceeds these limits is nondeductible.
Investment interest is deductible on the 1992 return and is limited to the
amount of net investment income. Investment interest is interest paid on debt
incurred to buy investment property. It does not include investments in passive
activities or activities in which the taxpayer actively participates, including the
rental of real estate. Net investment income is gross investment income (including
interest, dividends, taxable portion of annuities, certain royalties and net gains
but not net losses from sales) less investment expenses (excluding interest).
Investment interest disallowed because of last year's limitation may be carried
forward to the 1992 return.
Form 4952, Investment Interest Expense Deduction, is designed to calculate the
amount of carryover interest that may be deducted in the current tax year. The
carryover interest deduction is limited to the excess of current year's net
investment income over investment interest expense, and no deduction is allowed in
any year in which there is a net operating loss.
Personal interest is no longer deductible.
Medical expenses that exceed 7.5 percent of AGI are itemized deductions not
subject to the additional 2 percent AGI limit. "Medical expenses" are broadly
defined to include payments made for nearly all medical and dental services,
therapeutic devices and treatments, home modifications and additions made primarily
for medical reasons, travel and lodging expenses associated with qualified medical
care trips, legal fees required to obtain medical services, prescribed medicine and
drugs, special schooling and institutional care, qualified health insurance
premiums and the costs to acquire, train and maintain animals that assist
individuals with physical disabilities. Most cosmetic surgery, general health
maintenance, such as gym fees and weight loss programs, and well-baby care programs
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6
will not qualify. Remember that itemized medical expenses must be reduced by any
reimbursement, including health insurance paYments received.
Handicapped taxpayers' business expenses for impairment-related services at
their place of employment are itemized deductions not subject to the 7.5 percent or
2 percent AGI limits. Handicapped taxpayers are individuals who have a physical or
mental disability that is a functional limitation to employment.
Moving expenses are itemized deductions. Use Form 3903 to report moving
expenses and Form 4782 to report employer reimbursements.
Other itemized deductions not subject to the 2 percent AGI limit include
charitable deductions, state income and property taxes, and personal casualty
losses. This list is not complete.
Miscellaneous Deductions Subject To 2 Percent AGI Limit Include:
1. Unreimbursed employee business expenses including employment-related
educational expenses, travel, meals and entertainment expenses (subject to 80
percent rule), lodging, work clothes, dues, fees, and small tools and supplies.
Employee business expenses reimbursed under a nonaccountable plan are also
subject to the 2 percent AGI limit.
2.
Investment expenses, including legal, accounting, and tax counsel fees,
clerical help and office rental, and custodial fees.
3. Other deductions: professional dues, books, journals and safe deposit box
rental, job searching expenses, hobby expenses not exceeding hobby income,
office-in-the-home expenses, and indirect miscellaneous deductions passed
through grants or trusts, partnerships and S corporations.
Meal expenses must be directly related to the active conduct of the taxpayer's
trade or business (i.e. an organized business meeting or a meal at which business
is discussed). A meal taken immediately preceding or following a business meeting
will qualify if it is associated with the active conduct of the taxpayer's trade or
business.
Limitation for High-Income Taxpayers
Taxpayers with a 1992 AGI in excess of $105,250 ($52,625 if married and filing
separately) must reduce all itemized deductions except medical expenses, investment
interest, casualty losses, and wagering losses to the extent of wagering gains.
The reduction equals the lesser of 3 percent of excess AGI or 80 percent of the
applicable itemized deductions. Three percent of excess AGI will be the most
common reduction and will not be a major additional tax burden unless AGI is very
high. The 7.5 percent of AGI medical expense adjustment and 2 percent floor on
miscellaneous itemized de4uctions must be applied before the high-income deduction.
Example: Max and Molly Moneymaker's 1992 AGI is $122,000. Their itemized
deductions total $45,000 including $12,000 of deductible medical expenses (after
the 7.5 percent AGI deduction) and investment interest. They claim no casualty or
wagering losses. They must reduce their itemized deductions as follows:
$122,000 AGI - $105,250 maximum - $16,750 excess x .03 - $502.50.
$502.50 is less than (.80 x $33,000) - $26,400 of applicable itemized
deductions. They reduce itemized deductions by $502.50; $45,000 ­
$502.50 - $44,497.50 adjusted itemized deductions.
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7
Earned Income Credit for 1992
The extensively revised earned income credit rules from 1991 are still in
effect for 1992, but earned income brackets and credit amounts have increased.
There are three parts: (1) the basic earned income credit, (2) a health insurance
credit, and (3) a supplemental young child credit. If the credits exceed the tax
liability, the taxpayer will receive a refund. Filers use Schedule EIC and tables
A, B, and C to determine the credit amount.
The following table shows the 1992 earned income credit (EIC) rates for the
three parts of the program. Do not use these rates; use the IRS tables for
claiming EIC.
1992 Earned Income Credit Rates
Earned
Income 1
Basic Credit %
Two or More
One Child
Children
Health
Insurance
Credit %
New Child
Credit %
$1 -$7,520
17.6 2
18.4 2
6.1 to 6.0 2
5.1 to 5.0 2
$7,520-$11,840 3
17.6 to 11.2
$1,324
18.4 to 11.7
$1,384
6 to 3.8
$451
5 to 3.2
$376
$11,840-$22,370
11.2 to 0
11.7 to 0
3.8 to 0
3.2 to 0
1
2
3
Use AGI when it is $11,840 or more and greater than EI.
Rates are somewhat higher when EI is less than $1,000.
Maximum range, $ amount of credit is constant throughout.
The maximum basic credit is $1,324 if the family has one child and $1,384 if
there is more than one child. The credit peaks at earned income (EI) levels
between $7,520 and $11,840 and gradually goes to zero as EI and AGI levels reach
$22,370. It also gradually increases from zero at EI levels of zero to the maximum
stated earlier. Note that if AGI is greater than EI and AGI is greater than
$11,840, AGI rather than EI is used to compute the credit.
The health insurance credit of up to $451 applies to taxpayers who paid health
insurance premiums that covered one or more qualifying children. The credit
claimed may not exceed the health insurance premiums paid. If this credit is
claimed, the credit must be deducted from itemized medical and dental expenses.
Self-employed persons must deduct the credit from any amount used to calculate the
self-employed health insurance deduction on 1040. The health insurance credit
peaks at the same EI and AGI levels as the basic credit and has the "umbrella"­
shaped phaseouts.
A taxpayer with two children and eligible for health insurance credit can earn
a maximum 1992 EIC of $1,835 without the new child credit and $2,211 with it.
The supplemental young child credit maximum is $376 for 1992 and applies if a
child was born during the year. This credit will not increase if more than one
child is born. Claiming this credit disallows claiming the child and dependent
care credit or the exclusion of employer-provided dependent care benefits for the
same child. However, the credit and exclusion may be claimed if the family has
other children. The supplemental young child credit peaks at the same EI and AGI
levels as does the basic credit and has a similar phaseout.
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8
To be eligible for the Earned Income Credit, the taxpayer must have: (1) a
qualifying child; (2) earned income; (3) earned income and adjusted gross income,
each below $22,370; (4) a return that covers 12 months (unless a short-year return
is filed because of death); (5) a joint return if married (usually); (6) included
income earned in foreign countries and not deduct or exclude a foreign housing
amount; (7) not be used as a qualifying child making another person eligible for
the earned income credit.
There are three tests for a qualifying child:
relationship, residency, and age.
To meet the relationship test, the child must be (1) the taxpayer's son or
daughter or a descendant of the taxpayer's son or daughter, (2) the taxpayer's
step-son or step-daughter, or (3) the taxpayer's eligible foster or adopted child.
To meet the residency test, the child must live with the taxpayer in his or her
main home for more than half the year (all year if a foster child), and the home
must be in the U.S. However, a child that was born, or died, anytime in 1992 and
lived in the taxpayer's home will meet the residency test.
To meet the age test, the child must be (1) under 19 at the end of the year,
(2) a full-time student under 24 at the end of the year, or (3) permanently or
totally disabled at any time during the tax year, regardless of age.
Earned Income Credit Reminders for Farmers
If earned income is negative, there is no credit. Therefore, a farmer with a
negative Schedule F net farm profit would not get a credit unless there were wage
and Schedule C income more than enough to offset the loss on F, or the optional
method of reporting self-employment income is used.
A farmer who expects a negative net farm profit in 1992 might, by increasing
net farm profit to greater than zero or using the optional method of reporting up
to $1,600 of self-employment income, be able to collect an EIC, which would
partially or wholly cover the self-employment tax and thus provide a year's social
security coverage. Assuming nonearned income (such as gains from cattle sales)
plus earned income are less than $22,370, this strategy could work.
If AGI is greater than $22,370, there will be no credit even if earned income
is between zero and $22,370. Many dairy farmers could have a Schedule F profit in
the EIC range, but not get a credit (or at least have it limited) because of gains
from cattle sales on 4797 (or any other source of income that is not classified as
"earned") which would be included in AGI.
Before attempting to manage the net farm profit or self-employment income to
result in an EIC with which to pay the SE tax and provide a year's social security
credit, a farmer needs to understand the EIC rules and the interactions between
EIC, SE tax and income tax.
Form W-5. Earned Income Credit Advance Payment Certificate must be used by any
employee eligible for EIC to elect advanced payments from his or her employer. EIC
payments made by an employer to his or her employee offset the employer's liability
for federal payroll taxes. Use IRS tables to determine advanced payments of EIC.
Advanced payments are limited to the basic credit amount for one qualifying child,
regardless of the total number of children a taxpayer may have. An employer's
failure to make required advanced EIC payments is subject to the same penalties as
failure to pay FICA taxes. Employers of farm workers do not have to make advance
payments to farm workers paid on a daily basis (IRS Pub. 225).
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9
Estimated Tax Rules for 1992
The estimated tax rules for individuals were modified by the Emergency
Unemployment Compensation Act of 1991, signed 11/15/91. Prior to 1992, individuals
could avoid estimated tax penalties if less than $500 of tax (net of taxes
withheld) was owed, or by paying the lesser of 90 percent of the current year's
income tax liability or 100 percent of last year's income tax as a timely-deposited
estimated tax. Beginning with 1992, the 100 percent of last year's tax safe harbor
provision no longer applies when:
1.
Current year's modified AGI exceeds last year's AGI by more than $40,000
($20,000 if married and filing separate return in the current year), and
2.
Current year's AGI exceeds $75,000 ($37,500 if married and filing separate
return), and
3.
The taxpayer made estimated tax payments (or was assessed an estimated tax
penalty) during any of the three previous years.
If the 100 percent safe harbor is lost because of these new prov1s10ns, the
taxpayer must pay 90 percent of the tax shown on the current year's return as
estimated tax to avoid penalties, unless less than $500 of tax is owed. The new
provisions apply to NYS as well as federal estimated taxes through 1996. The
current year's modified AGI is AGI less any gain from the sale or exchange of a
principal residence, from an involuntary conversion, and certain qualified pass­
thru items.
Farmers and fishermen who receive at least two-thirds of their total gross
income from farming are exempt from estimated tax payments, providing they file and
pay taxes by March 1. New York State does not follow the federal definition of
gross income from farming, causing confusion among farm taxpayers.
Other Reminders for Individual Taxpayers
Child Care Credit is a nonrefundable credit available to taxpayers who incur
dependent care expenses so they may be gainfully employed. To be eligible, a
taxpayer must maintain a household for a dependent child under age 13, or a
dependent, including a spouse, who is incapable of self-care. The credit ranges
from 20 to 30 percent of employment-related child care expenses as taxpayer
adjusted gross income declines from $28,000 and over to $10,000 and under. The AGI
brackets and credits have not changed for 1992. Employment-related expenses may
not exceed $2,400 for one qualifying dependent and $4,800 for two or more. The
maximum credit available ranges from $480 to $720 for one qualifying dependent.
Double that amount for two or more dependents. The child care credit is calculated
on Form 2441 or on Schedule 2 of 1040A.
Qualifying employment-related expenses claimed may not exceed earned income and
must be reduced by reimbursement received from the taxpayer's employer. The child
care provider's TIN must go on the individual taxpayer's return unless the provider
is a tax-exempt organization. An individual claimer must re~ire the care provider
to complete and provide form W-10 which contains all the information needed to fill
out Form 2441 (Credit for Child and Dependent Care Expenses") or Schedule 2 of
1040A. Form W-10 (Dependent Care Provider's Identification and Certification) is
kept by the claimer. The provider does not file Form W-10with IRS.
Credit for the Elderly and the Disabled is a nonrefundable credit available to
qualified individuals age 65 and older and permanently disabled taxpayers who have
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10
retired. The 15 percent credit is small to moderate for elderly taxpayers with
very limited incomes. A single retiree with $10,000 or more of AGI and $3,750 or
more of social security would receive no credit.
Series EE United States Savings Bonds issued after·1989 may be purchased by
taxpayers, and if the proceeds are used to pay qualified higher education expenses
(tuition and fees) at eligible educational institutions, all or a portion of the
interest may be excluded from taxable income. These bonds are purchased at a
discount, and the interest is not reported until the bonds are redeemed. The
bondholder must be at least 24 years old. If all or part of the proceeds of the
bonds are not used for qualified higher education expenses, the exclusion of the
interest from taxable income will be partly or fully disallowed. In 1992, the
interest exclusion will be phased out for married taxpayers with modified adjusted
gross incomes ranging from $62,900 to $94,350, and individuals and heads of
households with modified AGIs ranging from $41,950 to $57,700. These amounts are
indexed to inflation. Form 8818, Optional Form to Record Redemption of College
Savings Bonds, may be used to maintain records needed to substantiate the interest
exclusion.
While these bonds appear to be a good method for taxpayers to fund education
expenses for their dependents, it is suggested that taxpayers fully acquaint
themselves with the rules before purchasing the bonds.
Interest Allocation Rules are still relevant. Interest expense is divided into
six categories: (1) trade or business, (2) investment, (3) passive activity, (4)
qualified residence interest, (5) interest on federal estate tax and (6) personal
interest. Interest paid in categories (1) and (5) is fully deductible while
interest in the other categories may be partially or completely disallowed.
Therefore, the taxpayer must allocate interest according to use of the debt on
which the interest is paid. The taxpayer who deposits loans in an account from
which funds are expended for various purposes such as paying for items for which
the money was borrowed, paying farm expenses, and paying living expenses may be
faced with great difficulty in complying with the interest allocation rules.
The allocation rules can be avoided by (1) not mixing the proceeds of a loan
with the proceeds of other loans or with money from other sources, (2) always using
the proceeds of a loan for only one purpose or for purposes that are in the same
category and (3) always using the proceeds from the sale of an asset to which debt
is allocated to payoff the debt or to make only one new expenditure.
Complexities arise and allocation is required when loan proceeds are used in
more than one expenditure category and when there is a change in use of an asset
purchased with debt proceeds. See IRS Publication 545 for more information.
Taxation of Mutual Fund Sales or Transfers
When taxpayers sell mutual fund shares, there usually will be either a gain or
loss. A transfer from one mutual fund to another is taxed the same as a sale. In
the situation where distributions have been reinvested in additional shares,
taxpayers often report more gain than they should. They subtract the original cost
from the sale price to calculate the gain and neglect to add the cost of the shares
that have been received as a result of reinvested distributions. The 1099 that is
received each year from the mutual fund reports the distribution and divides it
into dividends, capital gain, and nontaxable distributions. Tax is paid each year
on those reinvested distributions. The basis at the time of sale includes the
reinvested distributions. If the entire holding in the mutual fund is sold, the
original cost plus all the reinvested distributions is the basis that is subtracted
­
11
from the sale price (as shown on the 1099-B) to dete~ine the gain.
be return-of-capital distributions that will affect the basis.
There may also
If only part of the shares in the fund are sold, the calculation of the basis
is a bit more complicated. The taxpayer will need to compute the basis of the
number of shares sold. Usu~lly this would be done with a first-in, first-out
procedure. See Publication 564, Mutual Fund Distributions, for other methods of
computing basis and for additional information on mutual fund sales and
distributions.
The only way to accurately compute the basis when distributions have been
reinvested is to retain a complete record of the original purchase plus the cost of
all the shares purchased with reinvested distributions.
Mutual fund shares that were inherited or received as a gift have basis rules
similar to those for inherited and gifted property.
Example:
20 shares of NIC mutual fund purchased in 1962 for $17.45 per share
$349. NIC split 3 for 1 in 1966 and was merged into SGF in 1982. All
distributions have been reinvested. In 1992, there are 840.27 shares in SGF worth
$5.95 per share, for a total value of $4,999. It appears that the gain is $4,650.
Distributions reinvested from 1962 through 1992 total $4,424. Total basis is
$4,773. If all the shares were sold in 1992, gain would be $226. While most of
the gain would be long-term capital gain, the gain on shares purchased within a
year of sale would be short-term capital gain.
Now suppose that not all the shares are sold. Assume that 500 shares are sold
for $5.95 each, equaling $2,975. What is the gain? If the shares sold are deemed
to be the first 500 purchased, we need to find the basis of those 500 shares. In
this example, the first 500 shares have· a basis of $3,153, so there is a loss of
$2,975 - 3,153 - $178. If you wish to use this first-in, first-out method, you
must specify at the time of sale that these are the shares to be·sold.
If you wish to use an "average basis" method to calculate the cost per share,
you may choose between a "single category" and a "double category" method. To use
the single category method, the total basis of all the shares held is divided by
the total number of shares to get the basis per share. In the example above, the
total basis of $4,773 + 840.27 shares - $5.68 basis per share. If 500 shares are
sold, the basis of those shares is 500 x $5.68 - $2,840. If sold for $5:95, 500
shares produce a sale value of $2,975 and a gain of $135.
The double category method involves computing the average basis of the long­
term shares (held more than one year) separately from the basis of the short-term
shares. If you use the double category method, unless you specify otherwise at the
time of sale, the shares sold will first be from the long-term group and any excess
will be from the short-term group.
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12
CONSERVATION EASEMENTS AND DEVELOPMENT RIGHTS
Qualified Conservation Contribution
A donation of a perpetual conservation easement on a piece of real estate to a
governmental unit or a land ,trust may result in a deduction as a "qualified
conservation contribution" under Sec. 170(h). The donation of such an easement
normally would reduce the value of the property. The decline in the value of the
property due to the donation of the easement, as determined by a qualified
appraiser (if it exceeds $5,000), is the amount that may qualify as a charitable
contribution using Form 8283.
The taxpayer may not be able to deduct the full value of the qualified
conservation contribution in the year that the easement is donated. The deduction
will be limited to a percentage of adjusted gross income (probably 20 percent of
AGI) under the rules that apply to all charitable contributions. Donations that
exceed the limit based on adjusted gross income may be carried forward up to five
years subject to the AGI limits in the carryforward years.
Sale of Development Rights
A taxpayer who sells development rights gives up the right to develop the
property. How should the income from sale of the rights be reported? Rev. Ruling
77-414 states that the taxpayer may reduce basis before reporting gain as income.
Usually, when an interest in such a piece of property is sold, the basis must be
allocated between the part that is sold and the part retained. The gain would be
the difference between the sale price of the part sold and its basis.
If it is impossible to allocate the basis, the taxpayer is allowed to reduce
the basis on the entire property before' reporting any gain. Rev. Ruling 77-414
states that the sale of development rights does not require the allocation of basis
and allows the taxpayer to reduce the basis in land before recognizing gain on the
sale of development rights. Note: If the sale of development rights does not
cover the entire parcel (e.g., the house and some surrounding land is excluded), an
allocation of part of the basis to the land not included likely would still be
required.
USDA Wetland Reserve Program
The 1990 Farm Bill authorized the USDA to enter into permanent easement
agreements with farmland owners to restore to wetland some land that now is
cropped. New York is one of the pilot states, and it is possible that some bids
will be accepted during 1992; they certainly will be accepted in future years.
Landowners will be paid for the easement either in a lump sum or in installments
over a ten-year period. Landowners are also eligible to receive cost-sharing
payments from the USDA on expenses involved with the restoration to wetland status.
The cost-sharing payments will almost certainly be income to the landowners.
The easements are very similar to the sale of development rights. It seems
logical that the easement payments would have tax treatment similar to the sale of
development rights as discussed above.
­
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13
PROVISIONS APPLYING PRIMARILY TO BUSINESS ACTIVITY
Capital Gains
Although capital gains are treated as ordinary income, three potential tax
benefits still exist: (1) the maximum capital gain rate for individuals is 28
percent; (2) capital gain is not subject to self-employment tax.; (3) capital losses
are used to reduce capital gains without limitation. Corporate capital gains are
taxed at the corporation's regular tax rate.
Capital Losses
Net short-term capital losses and net long-term capital losses are combined for
the purpose of offsetting ordinary income. Net short-term capital losses and net
long-term capital losses may be used to offset up to $3,000 of a noncorporate
taxpayer's ordinary income ($1,500 for married filing a separate return). Any
excess capital losses may be carried forward and retain their character as short­
or long-term losses. Capital losses of a corporation are deductible only against
capital gains and may be carried back three years and forward five years.
Business vs. Hobby
To be fully deductible, business expenses must be incurred in carrying on a
trade or business that has an economic activity and a profit motive. Expenses
incurred in a hobby may be deducted only to the extent of hobby income, and they
are claimed as itemized deductions on Schedule A.
Taxpayers have two opportunities to assure that their enterprise will be
treated as a trade or business:
(1) The business is organized and conducted in good faith for the purpose of
making a profit and is characterized by activities that are accepted business
practices. In short, the taxpayer is trying to make a real profit and has
enough evidence in his(her favor to convince IRS or the court.
(2) The enterprise shows a profit in any three years out of five consecutive tax
years (two out of seven years for raising, breeding, racing or caring for
horses). If a taxpayer meets this criteria, it is presumed that he/she is
operating a business and no other proof is needed. New businesses may delay
the use of the presumption by filing Form 5213.
Refer to Chapter 5, Publication 225, or Chapter 21, Publication 334, for more
detailed information on not-for-profit farming.
Business Use of Home
Expenses associated with the business use of the home are deductible only if
they can be attributed to a portion of the home or separate structure used
exclusively and regularly as the taxpayer's place of business for any trade or
business, or a place where the taxpayer meets or "deals with" customers or clients
in the ordinary course of business.
"Exclusive use" means any nonbusiness use of that portion of the home claimed
for business use may nullify the claim. The good news is the tax court has
apparently abandoned the inflexible "focal point" test in favor of a "facts and
circumstances" test in deciding that management and administrative activi~ies
conducted in a taxpayer's home office were essential to the business.
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14
Recordkeeping rules for licensed or certified day-care providers using their
homes for business have been relaxed. They are no longer required to keep detailed
records of the exact time each room is used for day-care. A room that is available
for business use throughout the day, and is regularly used, will be considered used
for the entire day (Rev. Rul. 923). The portion of general home expenses that may
be claimed as a day-care business expense is determined by the percentage of total
house floor area and the portion of total annual hours used for day-care.
Schedule C filers who claim expenses for business use of the home must file
form 8829. This form requires a surprising amount of detail and has 52 possible
entries. Separate entries are required for direct expenses, such as painting the
room used as an office, and indirect expenses, such as electricity, which are used
in running the entire home. Form 4562 will be required if it is the first year the
taxpayer claims such expenses. Limitations on use of home expenses as business
deductions are calculated on 8829.
Health Insurance Premiums (effective for tax years beginning before 7/1/92 unless
extended>
Twenty-five percent of health insurance premiums paid by self-employed taxpay­
ers are deductible as an adjustment to income on 1040. The payments must be lim­
ited to health insurance coverage of the taxpayer and/or the spouse and dependents.
The deduction may not exceed earned income. The deduction does not reduce income
subject to self-employment tax and may not be included in medical expenses claimed
as itemized deductions. A taxpayer eligible for coverage in an employer's
subsidized health insurance plan may not deduct insurance premiums he or she pays
even if it is the taxpayer's spouse that is the employee. Currently, employers are
not required to provide health insurance to their employees to be eligible for the
25 percent deduction.
Corporate Tax Rates and Estimated Tax Payments
Corporate income tax rates have not changed for 1992.
1992 Corporate Income Tax Rates
Taxable Income
Tax Rate
Not over $50,000
15%
Over $50,000 but not over $75,000
25%
Over $75,000 but not over $100,000
34%
Over $100,000 but not over $335,000
39%*
Over $335,000
34%*
*Result of phaseout of benefits of the 15 and 25 percent
brackets by applying a 5 percent surcharge to income over
$100,000, the surcharge not to exceed $11,750.
The corporate alternative minimum tax rate is 20 percent. There is a $40,000
exemption that is reduced by 25 percent of the amount by which alternative minimum
taxable income exceeds $150,000 and is completely phased out when AMTI exceeds
$310,000. A corporation's AM! is its tentative minimum tax minus its regular tax
and a corporation may be eligible to take a minimum tax credit.
For tax years beginning after 6/30/92, estimated tax payments must be the
lesser of 97 percent (up from 93 percent) of current year tax liability or 100 per­
cent of previous year's taxes. Corporations with taxable incomes greater than $1
million in any of the last 3 years may not use the 100 percent safe harbor rule.
..
.
~.
15
Independent Contractor vs. Employee
The IRS has established and is using regulatory guidelines to find misuse of
the safe haven for independent contractors. The safe haven provision allows
employers to continue to treat workers as independent contractors and avoid income
tax and FICA withholding as .long as (1) the employer did not treat the worker as an
employee, (2) there is a "reasonable basis" for not classifying the worker as an
employee, and (3) all required tax returns are filed. IRS auditors are using the
following common law rules/factors that provide criteria for determining the status
of a worker or individual providing services:
1.
The worker is an employee if the employer has the right to direct and control
his/her work. Only the right to exercise control is required.
2.
The worker's designated title and grade have no consequence; it is the
existing employer/employee relationship that is critical.
3.
Following are criteria used by the IRS to determine the extent of employer
control. We have divided them into two groups: "high control" implies the
worker is an employee, "low/no control" favors independent contractor status.
These criteria are based on the 20 factors set out in IRS Audit Manual Exhibit
4640-1 and in Rev. Rul. 87-41. Any single fact or small group of facts is not
conclusive evidence of the presence or absence of control. An agent will
evaluate the reason for the existence or absence of each factor.
High Control
Work instructions required
Training required
Worker (contractor) is integrated into
the business operations
Services must be rendered personally,
they cannot be delegated or
subcontracted
Assistant workers are hired, supervised
or paid at the direction of "employer"
Continuing relationship exists
Set number of hours or full-time work
required
Work sequence is set by "employer"
Reports are required
Regular, periodic payments for services
are provided
Service can be terminated without
breach of contract/current liability
Low/no Control
No instructions required
No training needed
Service provided is common, easily
subcontracted
Worker (contractor) hires and
supervises own employees, sets
own hours
Work performed off employer's
premises
Worker sets sequence of work
Worker pays own expenses.
Worker provides tools & materials
Significant trade investment
required
Worker controls his/her profit/loss
Providing service for more than one
firm
Service made available to general
public
In addition to these factors that favor independent contractor status, an
employer may rely on one of the following types of authority:
1.
Court rulings and decisions, published rulings, or a private-letter ruling
issued to the taxpayer-employer;
2.
Past audit of taxpayer that approved this or similar practice;
3.
A long-standing, recognized practice of the applicable industry.
...
16
As a final resort, a taxpayer/employer may fill out and submit Form SS-8 which
will be used by the IRS to make the employee vs. independent contractor status
decision for the taxpayer. Filing SS-8 will trigger an IRS investigation ..
Business Use of Automobiles
Automobile expenses are 'deductible if incurred in a trade or business or in the
production of income. Actual costs or the standard mileage rate method may be
used. The 1992 standard mileage rate is 28 cents per mile for all business miles
driven. There is no longer a reduction in rate for over 15,000 miles and fully
depreciated autos.
Rural mail carriers are allowed a special mileage rate equal to 150 percent of
the basic standard mileage rate (42 cents for 1992). The special mileage rate
applies to all business use of an automobile (including vans, pickups, and panel
trucks) while performing "qualified services."
Nondiscrimination Rules for Qualified Employee Benefit Plans Delayed
Revised employee plan nondiscrimination regulations will not take effect until
after 1993. This gives administrators of qualified employee benefit plans extra
time to comply with regulations covering nondiscrimination, compensation limits and
other provisions. Tax-exempt organizations have a new effective date of January 1,
1996. Other employers must comply with the new regulations for tax years beginning
in 1994. Employers must continue to rely on a reasonable, good faith interpreta­
tion of the Code during this extended transition period.
Tax Preparation Fees
Rev. Rul. 92-29 states that sole proprietors who report business income on
Schedules C and/or F may deduct "expenses incurred in preparing that portion of the
return that relates to the taxpayer's business as a sole proprietor." In other
words, a portion of the tax preparation fees incurred by a small business are
deducted on Schedules C/F. The "personal share" may be claimed as an itemized
deduction subject to the 2 percent ACI floor. This ruling is more favorable than
LTR 9126014, 6/28/91, which classified all tax preparation fees as a miscellaneous
deduction.
Allocation of Assets
A taxpayer who acquires a trade or business after October 9, 1990 that includes
a group of assets to which goodwill or going concern value could be attached must
agree with the seller in writing on the allocation of any consideration or the fair
market value of any assets when allocating the purchase price to the various assets
acquired. This agreement is binding on both buyer and sel+er unless the IRS
determines that the allocation (or fair market value) is not appropriate.
A person who is a 10 percent (or more) owner before the transfer and the
transferee must furnish the IRS with certain information about transfers of
interests in entities if the 10 percent owner of any entity transfers an interest
in the entity, and as a result of this transfer, the owner (or related person)
enters into an employment contract, covenant not to compete, royalty or lessee
agreement, or other agreement with the transferee.
­
17
COMPLETING FORK 1065, SCHEDULES L, M-1 AND M-2
Beginning with 1991 tax returns, Schedules L, M-l and M-2" on Form 1065 are to
be completed unless the partnership's total receipts are less than $250,000, total
partnership assets are less than $250,000, and Schedules K-l are filed and fur­
nished to the partners on or before the due date of the partnership return, includ­
ing extensions. There is no longer an exemption for family farm partnerships with
10 or fewer partners.
Schedule L contains the tax basis partnership balance sheet at the beginning
and end of the tax year. The tax basis of the partnership assets will not equal
their fair market value, but the tax basis is important information to have in case
of a sale or dissolution. The total tax basis of assets less total liabilities
equals the total basis of partners' capital accounts. The basis of the capital
account may be negative from the beginning of the partnership where debts assumed
exceed the basis of assets contributed or if the partnership has sustained losses.
Schedule M-l (new in 1991) is the reconciliation of book income with Schedule K
income. Net income per books (line 1) would be net income from the partnership's
annual income statement. (This is not a statement based on market values.) Any
income or expense adjustments made on Schedule K are recorded on Schedule M-l
(lines 2 and 3). For example, guarranteed payments made to partners and deducted
in calculating book net income are an addition to income on Schedules K and M-l.
Excess deductions shown on the partnership books that cannot be claimed for tax
purposes are reported on line 6, Schedule M-l.
Schedule M-1, Reconciliation of Income Per Books with Income Per Return
1. Net income per books
$
2. Income included on Sch.
K, lines 1-7, not re­
corded on books this yr.
(itemize) :
__
3. Exp. recorded on books
this year not included on
Sch. K, lines l-12a, l7e,
and l8a (itemize):
a. Depreciation
b. Travel & entertainment
4. Total, lines 1-3
$
__
5. Income recorded on books this
year not included on Sch. K,
lines 1-7 (itemize):
$
a. Tax-exempt interest
6. Deductions included on Sch.
K, lines l-12a, l7e, and l8a,
not charged against book in­
come this year (itemize):
a. Depreciation
7. Total, lines 5 and 6
8. Income (loss) (Schedule K,
line 20a). Line 4 - line 7
_
$
-------­
$
Schedule M-2, Analysis of Partners' Capital Accounts, is the old reconciliation
schedule with a few more lines and modifications. Line 3 is the net income per
books which will include 4797 income on many farms. Formerly 4797 income was ex­
cluded in step 3 and added in step 4. Use entries on lines 4/7 to balance.
Schedule M-2, Analysis of Partners' Capital Accounts
1. Balance at beg. of year
$
2. Capital contributed
3. Net income per books
4. Other increases:
5. Total lines 1-4
6. Distributions:
a. Cash
b. Property
$
7. Other decreases:
$
8. Total lines 6 and 7
9. Balance, end of year
$
$
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18
PROVISIONS SPECIFIC TO AGRICULTURE
Expensing of Soil and Water Conservation Costs
In order to be expensed rather than capitalized, soil and water conservation
costs must be consistent with a conservation plan approved by the USDA Soil Conser­
vation Service or by a comparable state agency. Form 8645, Soil and Water Conser­
vation Plan Certification, is required. Costs for draining or filling of wetlands
or land preparation for center pivot irrigation systems may not be expensed.
Expensing of Land Clearing Repealed
Amounts paid after 1985 for land clearing are not eligible for expensing and
must be added to the land's basis (except routine brush clearing for land already
farmed).
Dispositions of Converted Wetlands or Highly Erodible Croplands
Any gain on the disposition of converted wetlands or highly erodible cropland
is treated as ordinary income rather than capital gain. Any loss on such
dispositions is treated as long-term capital loss. The definitions of "converted
wetlands" and "highly erodible cropland" are contained in the Food Security Act of
1985. The provision applies to land converted to farming after March I, 1986.
Limitation on Certain Prepaid Farming Expenses
The limitation applies to prepaid expenses of cash basis taxpayers to the
extent they exceed 50 percent of the deductible farming expenses of the taxable
year (other than the prepaid expenses).
There are two exceptions to the 50 percerit test for a "qualified farm related
taxpayer": (1) extraordinary circumstances such as a government crop diversion
program; (2) if the 50 percent test is satisfied on the basis of aggregating the
prepaid expenses and the farming expenses for the previous' three years.
A "farm related taxpayer" is one (i) whose principal residence is on a farm,
(ii) who has a principal occupation of farmer or (iii) who is a member of the
family of a taxpayer described in (i) or (ii).
Income from Cancellation of Debt
Some New York farmers are likely to have debt cancelled by their lenders during
1992 or other years. The tax code specifies that cancellation of debt, called
discharge of indebtedness income (011), is ordinary income to the borrower. In
many situations, the 011 does not result in income that is reported and taxed. In
return for not reporting the income, the taxpayer must reduce "tax attributes,"
such as investment credit, net operating losses and basis in assets. Reducing
these attributes may result in tax liability for the taxpayer in future years.
There are two sets of rules that control reporting of cancelled debt. One
applies to bankrupt and insolvent debtors, including farmers. The other set
applies to solvent farmers. The bankrupt and insolvent rules provide that if the
cancelled debt is greater than the total tax attributes, the excess cancelled debt
is not reported and, therefore, does not result in tax liability. Some insolvent
farmers who have debt cancelled by lenders will find that enough debt is cancelled
so that they become solvent. Therefore, they are subject to both sets of rules
because once they become solvent they are treated under the solvent farmer rules.
­
19
Some of the insolvent debtor rules are applied to solvent farmers for debt
discharged after April 9, 1986. The discharged debt must be "qualified farm
indebtedness". To meet the qualified farm indebtedness definition, (1) the debt
must have been incurred directly in connection with the operation of the farm
business, (2) 50 percent or more of the aggregate gross receipts of the farmer for
the three previous years must have been attributable to farming and (3) the
discharging creditor must be (a) in the business of lending money and (b) not
related to the farmer, did not sell the property to the farmer and did not receive
a fee for the farmer's investment in the property. These rules are quite
restrictive and will prevent some solvent farmers from using tax attributes to
offset 011. For example, a farmer with 011 who had purchased the real estate or
other property from the lender who later cancelled part or all of the debt would
not meet the QFI rules, at least for the 011 related to this property.
Solvent farmers must reduce tax attributes in exchange for not reporting 011 as
income. Also, for solvent farmers, the basis reduction for property owned by the
taxpayer must take place in the following order: (1) depreciable assets, (2) land
held for use in the trade or business of farming and (3) other property. The limit
on reducing the basis below the remaining debt does not apply to solvent taxpayers.
Unlike the rules for insolvent debtors, any 011 rema1n1ng after the tax
attributes have been reduced must be included in taxable income. In other words,
if the 011 exceeds the total of the tax attributes, all the tax attributes will be
given up and the excess of 011 over the tax attributes will be included in income
and therefore may cause a tax liability.
Oisaster Payments and Crop Insurance
Normally, cash basis farmers are required to report disaster payments and crop
insurance benefits in the year the payments are received. On February 23, 1990 the
Treasury issued a Temporary Regulation (1.451-6T) that allows the taxpayer to elect
to report such benefits in a later year if the taxpayer can show that under normal
business practice the income from the crop for which the benefits were received
would have been reported in a later year. This applies to federal payments
received as a result of (1) the destruction of, or damage to, crops caused by
drought, flood or any other natural disaster, or (2) the inability to plant crops
because of such a natural disaster. This regulation is effective for payments
received after Oecember 31, 1973. See Publication 225 for details on making the
election. Revenue Ruling 91-55 reaffirms that disaster payments are treated the
same as crop insurance and overrules Rev. Rul. 75-36 which stated the opposite.
In 1991, dairy and other livestock farmers with at least 40 percent loss in
feed production in more than 20 counties were eligible for payments under the
Livestock Feed Program (LFP) administered by ASeS. In a few counties, farmers in
this situation were eligible to receive subsidized grain from eee stocks under the
Emergency Feed Assistance Program (EFAP). The LFP payments, as well as the subsidy
portion of the eee grain, are to be included in income. IRS will know about both
types of income. Some of the payments were received in 1992.
Many New York counties were declared disaster areas in 1992. Some farmers in
these counties will receive disaster payments from the federal government in either
1992 or 1993.
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20
DEPRECIATION AND COST RECOVERY
The modified accelerated cost recovery system (MACRS) provides for eight
classes of recovery property, two of which may be depreciated only with straight
line and applies to property placed in service after 1986. MACRS provides for less
accelerated depreciation on most property than did ACRS, but there are exceptions.
Pre-MACRS property will continue to be depreciated under the ACRS or pre-ACRS
rules. Therefore most taxpayers will be dealing with MACRS, ACRS, and the
depreciation rules that apply to property acquired before 1981. This bulletin
concentrates on the MACRS rules but some ACRS information is included. Additional
information on ACRS and pre-ACRS rules can be found in prior issues of this manual
or the Farmers Tax Guide.
pepreciable Assets
A taxpayer is allowed cost recovery or depreciation on purchased machinery,
equipment, buildings, and on purchased livestock acquired for dairy, breeding,
draft, and sporting purposes unless reporting on the accrual basis and such
livestock are included in inventories. Depreciation must be claimed by the
taxpayer who owns the asset. A taxpayer cannot depreciate property that he or she
is renting or leasing from others. The costs of most capital improvements made to
leased property may be depreciated by the owner of the leasehold improvements under
the same rules that apply to owners of regular depreciable property.
Depreciation or cost recovery is not optional. It should be claimed each year
on all depreciable property. An owner who neglects to take depreciation when it is
due is not allowed to recover the lost depreciation by claiming it in a later year.
Lost depreciation may be recovered by filing an amended return.
Farmers are required to capitalize pre-productive expenses of trees and plants
if the pre-productive period is more than two years, unless they elect not to
capitalize, which triggers a requirement to use straight line depreciation. Such
capitalized expenses are depreciated when the productive period starts. Taxpayers
other than farmers are also subject to uniform capitalization rules.
MACRS Classes
The MACRS class life depends on the ADR midpoint life of the property. For
some items, the ADR midpoint life was specifically changed by TRA 1986. For
example, autos and light duty trucks' were given an ADR life of five years which
moves them from the 3-year ACRS to the 5-yearMACRS class.
MACRS Class
ADR Midpoint Life
3-year
5-year
7-year
10-year
lS-year
20-year
4 years or less
More than 4 but less than 10
10 or more but less than 16
16 or more but less than 20
20 or more but less than 2S
25 or more other than 1250 property with an ADR life
of 27.S or more
27.S-year
3l.S-year
Residential rental property
Nonresidential real property
..
21
Assets are placed in one of the eight MACRS classes regardless of the useful
life of the property in the taxpayer's business. Examples of the types of farm
assets included in each MACRS class are shown below.
Three-year property:
1. Section l24S property with an ADR class life of four years or less. This
includes over-the-road tractors. It also includes hogs for breeding purposes
but not cattle, goats or sheep held for dairy or breeding purposes because the
ADR class life of these animals is greater than four years.
2. Section l24S property used in connection with research and experimentation.
Few farmers will have this type of property.
3. Race horses more than two years old when placed in service and all other horses
more than 12 years old when placed in service.
Five-year property:
1. All purchased dairy and breeding livestock (except hogs and horses included in
the 3 or 7-year classes).
2. Automobiles, light trucks (under 13,000 Ibs. unladen), and heavy duty trucks.
3. Computers and peripheral equipment, typewriters, copiers and adding machines.
4. Logging machinery and equipment.
Seven-year property:
1. All farm machinery and equipment.
2. Single purpose livestock and horticultural structures (if placed in service
before 1989), silos, grain storage bins, fences, paved barnyards, water wells,
and drain tiles.
3. Breeding or work horses.
Ten-year property includes single purpose agricultural structures and orchards and
vineyards placed in service after 1988.
Fifteen-year property:
1. Depreciable land improvements such as sidewalks, roads, bridges, drainage
facilities and fences other than farm fences (which are in the 7-year class).
Does not include land improvements that are explicitly included in any other
class, or buildings or structural components.
2. Orchards, groves, and vineyards when they reach the production stage if they
were placed in service before 1989.
Twenty-year property includes farm buildings such as general purpose barns and
machine sheds.
27.S-year property includes residential rental property.
3l.S-year property includes nonresidential real property.
-
22
ACRS, KACRS and Alternative KACRS
Recovery Periods for Common Farm Assets
Asset
Airplane
Auto (farm share)
Calculators and copiers
Cattle (dairy or breeding)
Citrus groves
Communication Equipment
Computer and peripheral equipment
Computer software
Copiers
Cotton ginning assets
Farm buildings (general purpose)
Farm equipment and machinery
Fences (agricultural)
Goats (breeding or milk)
Grain bin
Greenhouse (single purpose structure)
Helicopter (agricultural use)
Hogs (breeding)
Horses (nonrace, less than 12 years of age)
Horses (nonrace, 12 years of age or older)
Logging equipment
Machinery (farm)
Mobile homes on permanent
foundations (farm tenants)
Office equipment (other than calculators,
copiers or typewriters)
Office furniture & fixtures
Orchards
Paved lots
Property with no class life
Rental property (nonresidential)
Rental property (residential)
Research property
Sheep (breeding)
Silos
Single purpose agricultural structure
Single purpose horticultural structure
Solar property
Tile (drainage)
Tractor units for use over-the-road
Trailer for use over-the-road
Truck (heavy duty, general purpose)
Truck (light, less the 13,000 Ibs.)
Typewriter
Vineyard
Wind energy property
ACRS
5
3
5
5
5
5
5
5
5
5
Recovery Period
Alternative
MACRS
MACRS
5
5
5
5
6
15
20
10
7
5
7
5
7
19
20
5
5
3
5
5
5
3
5
3
5
5
7
7
5
7
10**
5
6
7
5
12*
6
12
25
10
10
5
10
15
5
3
7
3
5
7
10
10
10
15
20
5
5
5
5
5
7
7
10
10
20
20
12
19
19
5
3
5
5
5
5
5
3
5
5
3
5
~
5
10***
15 .
7
31. 5
27.5
5
5
7
10**
10**
5
15
3
.5
5
5
5
10***
5
*No class life specified. Therefore, l2-year life assigned.
**7 if placed in service before 1989.
***15 if placed in service before 1989.
6
3
6
10
40
40
12*
5
12*
15
15
12*
20
4
6
6
5
6
20
12*
-
23
Cost Recovery Methods and Options
Accelerated cost recovery methods for MACRS property are shown below.
Depreciation on farm property placed in service after 1988 is limited to 150
percent declining balance (DB) rather than the 200 percent available for nonfarm
property. There is an exception from the 150 percent DB rule for property placed
in service before July 1, 1989 that was under construction or under a binding
written contract before July 14, 1988. In addition, there are two straight line
(SL) options for the classes eligible for rapid recovery. SL may be taken over the
MACRS class life or, using alternative MACRS depreciation system, over the ADR
midpoint life. A fourth option is 150 percent DB over the ADR midpoint life, the
depreciation method required for alternative minimum tax purposes discussed under
Alternative Minimum Tax.
Orchards and vineyards placed in service after 1988 are not eligible for rapid
depreciation. They are in the 10-year class and depreciation is limited to
straight line.
Class
Most Rapid MACRS Method Available
3, 5, 7 and 10-year
Farm assets: 150 percent DB if placed in service
after 1988. 200 percent if placed in service
1987 through 1988. (See exception for orchards
and vineyards above.)
Nonfarm assets:
SL.
200 percent DB with switch-over to
15 and 20-year
150 percent declining balance with switch-over to SL
27.5 and 31.5-year
Straight line only
The MACRS law does not provide for standard percentage recovery figures for
each year. However, tables have been made available by IRS and several of the tax
services.
Annual Recovery (Percent of Original Depreciable Basis)
(The 150% DB percentages are for 3, 5, 7 and 10 year class
farm property placed in service after 1988.)
Recovery
Year
1
2
3
4
5
6
7
8
9
10
11
12-15
16
17-20
21
3 Year Class
200% 150%
d.b.
d.b.
5 Year Class
200% 150%
d.b.
d.b.
7 Year Class
200%
150%
d.b.
d.b.
33.33
44.45
14.81
7.41
20.00
32.00
19.20
11.52
11.52
5.76
14.29
24.49
17.49
12.49
8.93
8.92
8.93
4.46
25.00
37.50
25.00
12.50
15.00
25.50
17.85
16.66
16.66
8.33
10.71
19.13
15.03
12.25
12.25
12.25
12.25
6.13
15 Yr. 20 Yr.
10 Year Class Class Class
200%
150%
150% 150%
d.b.
d.b.
d.b. d.b.
10.00
18.00
14.40
11.52
9.22
7.37
6.55
6.55
6.55
6.55
3.29
7.50
13.88
11.79
10.02
8.74
8.74
8.74
8.74
8.74
8.74
4.37
5.00
9.50
8.55
7.69
6.93
6.23
5.90
5.90
5.90
5.90
5.90
5.90
3.00
3.75
7.22
6.68
6.18
5.71
5.28
4.89
4.52
4.46
4.46
4.46
4.46
4.46
4.46
2.25
-.
24
Half-Year and Mid-Month Conventions
HACRS provides for a half-year convention in the year placed in service
regardless of the recovery option chosen. Unlike ACRS, a half-year of recovery may
be taken in the year of disposal. No depreciation is allowed on property acquired
and disposed of in the same year. Property in the 27.5 and 3l.5-year classes is
subject to a mid-month convention in the year placed in service.
Alternative MACRS Depreciation
Alternative HACRS depreciation is required for some types of property and is a
straight line system based on the alternative HACRS recovery period. Farmers who
are subject to capitalization of preproductive expenses, discussed more fully
later, may elect to avoid capitalization, but if they do so, they must use
alternative HACRS on all property. The recovery periods are, in general, the ADR
midpoint lives.
Election to Expense Depreciable Property
The Section 179 expense deduction is available under MACRS in the amount of
$10,000. The $10,000 is phased out for any taxpayer who places over $200,000 of
property in service in any year, with complete phaseout at $210,000. Property
eligible for Sec. 179 is now defined as Section 1245 property to which Section 168
(depreciation/amortization) applies. However, Congress may pass legislation to
make some Sec. 1245 property ineligible.
In the case of partnerships, the $10,000 limit applies to the partnership and
also to each partner as an individual taxpayer. A partner who has Sec. 179
allocation from several sources could be in a situation where not all of the 179
allocated to him/her could be used because of the $10,000 limitation. The same
concept applies to S corporations and shareholders.
The amount of the Section 179 expense election is limited to the amount of
taxable income of the taxpayer that is derived from the active conduct of all
trades or businesses of the taxpayer during the year. Taxable income for the
purpose of this rule is computed without regard to the Section 179 deduction. Any
disallowed Section 179 deductions are carried forward to succeeding years. The
deduction of current plus carryover amounts is limited to $10,000 in any year.
Proposed amendments to the 179 regulations provide that wage and salary income
qualifies as income from a trade or business. Therefore, such income can be
combined with income (or loss) from Schedules C or F in determining income from the
active conduct of a trade or business when calculating the allowable 179 deduction.
Section 1231 gains and losses from a business actively conducted by the taxpayer
are also included. Including these items is a much broader interpretation of
"active" than generally believed in earlier years.
Gains from the sale of Section 179 assets are treated like Section 1245 gains.
The amounts expensed are recaptured as ordinary income in the year of sale. The
Section 179 expense deduction is combined with depreciation allowed in determining
the amount of gain to report as ordinary income on Part III of Form 4797.
If post 1986 property is converted to personal use or if business use drops to
50 percent or less, the Section 179 expense recapture is invoked no matter how long
the property was held for business use. The amount recaptured is the excess of the
179 deduction over the amount that would have been deducted as depreciation.
•
25
With repeal of federal investment credit, only the New York IC will be lost
when Section 179 is used. Every farmer who has purchased MACRS property in 1992
should consider the $10,000 expense deduction. It should not be used to reduce
adjusted gross income below the standard (or itemized) deductions plus exemptions
unless an additional reduction in 1992 self-employment tax is worth more than
depreciation in a future tax year. Also, the taxpayer must be sure not to use more
179 deduction than the amount of taxable income from the conduct of an active trade
or business.
Mid-Quarter Convention
If more than 40 percent of the year's depreciable assets (other than 27.5 and
31.5-year property) are placed in service in the last quarter, all of the assets
placed in service during that year must be depreciated using a mid-quarter
convention. The assets placed in service during the last quarter will earn only
12.5 percent rather than 50 percent of a year's depreciation. Assets placed in
service during the first, second and third quarters will earn 87.5, 62.5 and 37.5
percent, respectively. Beginning in 1991, the amount expensed under Section 179 is
no longer considered in applying the 40 percent rule. In other words, the amount
expensed under Sec. 179 can be taken on property acquired in the last quarter,
which may help avoid the mid-quarter convention rule.
Example: Ed placed $100,000 worth of property in service during 1992. If this
was all 7-year farm property, he could expense $10,000 and have $9,639 of
depreciation. But if $50,000 of the property was placed in service in the last
quarter, Ed would be subject to the mid-quarter convention rules. Depreciation of .
the $40,000 (after the $10,000 expensing) would be $1,072. If the remaining
$50,000 had been placed in service during the second quarter, it would be
depreciated using a mid-quarter convention in that quarter and depreciation would
be $6,695. Total depreciation would be $6,695 + $1,072 + $10,000 - $17,767 vs. the
$19,639 that would have been available under the regular mid-year convention.
Note that if the 40 percent rule is triggered, the depreciation on property
acquired in the first and second quarters actually increases. Taxpayers are not
allowed to use the mid-quarter rules voluntarily.
HACRS Property Class Rules
For 3, 5, 7, and 10-year MACRS property, the same recovery option must be used
for all the property acquired in a given year that belongs in the same MACRS class.
Taxpayers do not have the option to establish subdivisions of a property class.
For example, if a farmer purchased a new tractor, forage harvester and combine in
1992, all belong in the 7-year property class. The farmer may not recover the
tractor over seven years with rapid recovery (150 percent DB) and the other items
over seven or ten years with SL. However, the taxpayer may choose a different
recovery option for property in the same MACRS class acquired in a subsequent year.
For example, a farmer could have chosen SL 10-year recovery for a tractor purchased
in 1991 (7-year property) but could have chosen 150 percent DB for seven years for
a combine purchased in 1992. Keep in mind that 150 percent DB would be used on any
other 7-year property purchased in 1992.
A taxpayer may select different recovery options for different MACRS classes
established for the same year. For example, a taxpayer could select fast recovery
on 5-year property, straight line over seven years on 7-year property, and straight
line over 25 years on 20-year property.
­
26
Some Special Rules on Autos and Listed Property
There are special rules for depreciation on automobiles and other "listed
property" acquired after June 18, 1984. If the car is used less than 100 percent
in the business, the maximum allowance is reduced, and if used 50 percent or less,
the Sec. 179 deduction is not allowed. The maximum first year allowance for
depreciation and the Section 179 expense is $2,760 on cars placed in service in
1992. Cellular telephones were added to listed property for 1990 and later years.
Additional Rules
For property placed in service after 1986, accelerated depreciation in excess
of 150 percent, calculated with the alternative MACRS life, becomes an income
adjustment subject to inclusion in alternative minimum taxable income. If SL
alternative MACRS life depreciation is used for regular tax calculations, it must
be used for AMI.
Salvage value is disregarded when computing MACRS recovery. MACRS rules allow
half a year's depreciation in the year of disposition (property acquired after
12/31/86) using the half-year convention. Recovery may be claimed in the year of
disposition (based on the months held in that year) on 27.5 and 3l.5-year property.
Gain to the extent of depreciation whether rapid or SL on all Section 1245 3,
5, 7, 10 and IS-year MACRS property is ordinary income. There is no recapture of
depreciation on property in the 20-year class if straight line recovery is used
(see A Review of Farm Business Property Sales for more on depreciation recapture).
Property placed in service during a short tax year is subject to special
allocation rules that vary with the applicable convention used. Details are
provided in Pub. 534.
Choosing Recovery Options
Taxpayers will maximize after-tax income by using Section 179 and rapid
recovery on 3, 5, 7, 10, and IS-year MACRS property, assuming the deductions can be
used to reduce taxable income and do not create an AMT adjustment that results in
AMT liability. To simplify depreciation records and avoid AMT adjustments,
taxpayers may prefer 150 percent declining balance over the ADR midpoint life. The
taxpayer who will not be able to use all the deductions in the early years may want
to consider one of the straight line options.
Using straight line rather than 150 percent declining balance on 20-year
property will preserve capital gain treatment at the time of disposal. However,
this is not of great value to most taxpayers because the 3 percent capital gain
break applies only to taxpayers in the 31 percent bracket. For most taxpayers, the
choice of the best recovery option for 20-year MACRS property should be based on
the value of concentrating depreciation in early years versus spreading it out.
The time value of money makes 1992 depreciation more valuable than that used in
later years. However, depreciatiQn claimed to reduce taxable income below zero is
depreciation wasted.
Reporting Depreciation and Cost Recovery
Form 4562 is used to report the Section 179 expense election, depreciation of
recovery property, depreciation of nonrecovery property, amortization, and specific
information concerning automobiles and other listed property. Depreciation, cost
recovery, and Section 179 expenses are combined on 4562 and entered on Schedule F.
...
27
However, partnerships will transfer the 179 expense election to Sch. K, Form 1065
rather than combining it with other items on 4562. Since it is excluded when
calculating net earnings for self-employment on Sch. K and K-l, include it as an
adjustment to net farm profit on Sch. SE.
ACRS Recovery Percentages
Tables for rapid recovery of ACRS property are available in the Farmers Tax
Guide and Pub. 534. A table for straight line ACRS depreciation is shown below.
Straight Line Depreciation Options for ACRS 3, 5, 10, 15, 18, & 19-Year Property
Straight Line
Option
1st Year
Intermediate Years
3-year class options
3 years
5 years
12 years
1/6
1/10
1/24
1/3 in each of next 2 years
1/5 in each of next 4 years
1/12 in each of next 11 years
1/6
1/10
1/24
5-year class options
5 years
12 years
25 years
1/10
1/24
1/50
1/5 in each of next 4 years
1/12 in each of next 11 years
1/25 in each of next 24 years
1/10
1/24
1/50
10-year class options
10 years
25 years
35 years
1/20
1/50
1/70
1/10 in each of next 9 years
1/25 in each of next 24 years
1/35 in each of next 34 years
1/20
1/50
1/70
IS-year class options
15 years
1/180 per mo.
35 years
1/420 per mo.
45 years
1/540 per mo.
1/15 in each of next 14 years
1/35 in each of next 34 years
1/45 in each of next 44 years
balance
balance
balance
l8-year class options
18 years
1/216 per mo.*
35 years
1/420 per mo.*
45 years
1/540 per mo.*
1/18 in each of next 17 years
1/35 in each of next 34 years
1/45 in each of next 44 years
balance
balance
balance
19-year class options
19 years
1/228 per mo.*
1/19 in each of
35 years
1/420 per mo.*
1/35 in each of
45 years
1/540 per mo.*
1/45 in each of
*Use one-half this amount for the month of acquisition
Last Year
balance
next 18 years
next 34 years
balance
next 44 years
balance
(after 6/22/84).
Accurate Records Needed
Accurate and complete depreciation records are basic to reliable farm income
tax reporting and good tax management. Depreciation and cost recovery must be
reported on Form 4562. A complete depreciation and cost recovery record is needed
to supplement form 4562. It is not necessary to submit the complete list of items
included in the taxpayer's depreciation and cost recovery schedules.
-.
28
REVIEW OF UNIFORM CAPITALIZATION RULES FOR FARMERS
The preproductive costs of raising livestock are exempt from the uniform
capitalization rules in tax years ending after December 31, 1988. The exemption
does not apply to large farm corporations, partnerships or tax shelters that are
required to use accrual accounting, or to the preproductive costs of establishing
fruit trees, vines and other applicable plants.
Fruit Growers and Nurserymen
Plants subject to capitalization rules will include fruit trees, vines,
ornamental trees and shrubs, and sod providing the preproductive period is 24
months or more. An evergreen tree which is more than six years old when harvested,
(severed from the roots), is not an ornamental tree subject to capitalization
rules. Timber is also exempt. If trees and vines bearing edible crops for human
consumption are lost or damaged by natural causes, the costs of replacement trees
and vines do not have to be capitalized.
"The preproductive period of a plant begins when the plant or seed is first
planted or acquired by the taxpayer. It ends when the plant becomes productive in
marketable quantities or when the plant is reasonably expected to be sold or
otherwise disposed of." [Temp. Reg. 1.263A-lT(c) (4) (it) (B)]. The preproductive
periods of plants raised commercially in the U.S. can be determined from nationwide
weighted averages.
Fruit growers who choose to capitalize will need to establish reasonable
estimates of the preproductive costs of trees and vines. The farm-price method
could be used by nurserymen to establish their preproductive costs of growing
trees, vines, and ornamentals. Capitalization requires the recovery of orchard,
vineyard, and ornamental tree preproductive period expenses over 10 years. If
growers elect not to capitalize, they must use alternative MACRS to recover the
costs of trees and vines (20 year straight line) and all other depreciable assets
placed in service. Only the preproductive period growing costs may be expensed.
Old Livestock Capitalization Rules
Livestock capitalization rules and elections adopted in 1987 and 1988 still
affect tax reporting.
1. Farmers who revoked the election to use alternative MACRS and those that were
never subject to capitalization rules should check "does not apply" on line G
of their 1992 Schedule F.
2. Assets placed under alternative MACRS depreciation in 1987 and 1988 must remain
under this method of cost recovery until fully depreciated or disposed of.
Preproductive period costs capitalized in 1987 and 1988 will remain on the
depreciation schedule until the capitalized costs are fully recovered.
3. The sales of animals subject to capitalization rules are Section 1245
transactions. Unrecovered capitalized costs become the basis, and gain to the
extent of depreciation claimed is ordinary income. Farmers who elected out of
capitalization are also subject to the Section 1245 recapture rules. When
raised dairy and breeding livestock are sold, any gain. to the extent of
preproductive period costs that would have been capitalized if the election had
not been made, must be recaptured as ordinary income. IRS says you cannot use
safe harbor values for this calculation.
...
29
CASUALTY LOSSES, GAINS, AND INVOLUNTARY CONVERSIONS
A casualty includes the damage or loss resulting from a sudden, identifiable,
unexpected event such fire, flood, wind, lightning, freezing, storm and accident.
Business Casualty Losses and Gains
Fire and storm losses of farm buildings, vehicles, equipment and purchased
livestock will result in casualty losses or gains. The deductible loss is the
lesser of the adjusted basis or loss in market value, minus any insurance received.
When the insurance is greater than the loss in value or basis, there is a casualty
gain that may be treated as an involuntary conversion. When calculating casualty
losses and gains, the remaining basis. is decreased by any insurance received.
Losses of raised crops and livestock are not deductible to the cash basis
farmer because the value of these production items has not been reported as income.
The costs of replacing raised crops is a business expense; crop insurance is
ordinary income. Insurance proceeds from losses of raised dairy and breeding
livestock are casualty gains.
Example: W.L. Insured lost a barn to fire in July 1992. The barn, hay and
machinery stored in the barn were a total loss. Here is a summary of the
information required to calculate the casualty loss or gain.
Item
Barn
Hay, raised
Machinery
Market
value loss
$75,000
4,000
30,000
Tax basis
$15,000
0
10,000
Insurance
received
$75,000
4,000
30,000
Result
$60,000 casualty gain
$ 4,000 ordinary gain
$20,000 casualty gain
Since the tax or adjusted basis is less than the loss in market value, the tax
basis is subtracted from insurance received to determine the casualty loss or gain.
W.L. has two casualty gains totaling $80,000. The $4,000 insurance from raised hay
is Schedule F income. W.L.'s casualty gain is an involuntary conversion. He may
elect to postpone the g ain if he plans to replace the barn and machinery. If his
new barn costs $80,000, its basis will be $80,000 - $60,000 - $20,000.
Involuntary Conversion
Casualty gains and gains from forced sales due to condemnation, threat of
condemnation, are involuntary conversions. Gains from. the sale or death of any
diseased livestock (IRC Sec. 1033(d», or dairy, draft and breeding livestock sales
caused by drought (Sec. 1033(e», are involuntary conversions. Reporting gains
from involuntary conversions may be postponed if replaced with property similar or
related in service or use. The replacement period ends two years after the close
of the year in which any part of the gain is realized.
Postponement of gains is an election that must be made on the tax return for
the year in which the gain first occurred. Attach a statement that explains what
the gain is, how it was determined, and when it will be reported. Another
statement is requested in the year the replacement property is acquired, explaining
what it is and how its basis was determined. If the property is not replaced
within the required period, the return for the election year must be amended to
report the gain realized.
-.
'
30
GENERAL BUSINESS CREDIT
General business credit (GBC) is a combination of investment tax credit
(generally repealed 1/1/86), targeted jobs credit, alcohol fuels credit,
research credit, low-income housing credit, and the new disabled access credit .
. Form 3800 is used to claim GBC for the current year, to apply carryforward from
prior years, and to claim carryback GBC from future years. The credit allowable
is limited to tax liability up to $25,000 plus 75 percent of the taxpayer's net
tax liability exceeding $25,000. Special limits apply to married persons filing
separate returns, AMT taxpayers, controlled corporate groups, estates and
trusts, and certain investment companies and institutions [Sec. 46(e)(i)].
Review of Federal Investment Credit
Federal investment tax credit (IC) was one of the most important features of
farm tax reporting and tax management before 1986. It was repealed for most
property placed in service after 12/31/85. In 1992, IC may be earned on
rehabilitated buildings, qualified reforestation expenses, and certain business
energy investments. IC (Sec. 45(a)(1)) is 10 percent of the amount of qualified
investment. There are more liberal allowances for some rehabilitated buildings.
The credit is a direct reduction against income tax liability. If it cannot be
used in the year it is earned, it can be carried back and carried forward to
offset tax liability in other years. If property is disposed of before credit
claimed is fully earned, the credit must be recomputed to determine the amount
to recapture. Form 3468 is used for computing IC.
Rehabilitated buildings (expenditures) credit is 10 percent for a qualified
rehabilitated building and 20 percent for a certified historic structure. The
building (other than a certified historic structure) must have been first placed
in service before 1936. Expenditures for the interior or exterior renovation,
restoration or reconstruction of the building qualify for the credit. Costs for
acquiring or completing a building or for the replacement or enlargement of a
building do not qualify. The credit is available for all types of buildings
that are used in business or productive activities except buildings that are
used for residential purposes. However, the credit may be earned on a certified
historic structure that is used for residential purposes. The use of a building
is determined based on its use when placed in service after rehabilitation.
Thus, rehabilitation of an apartment building for use as an office building
would render the expenditure eligible for credit. The basis for depreciation
must be reduced by 100 percent of the investment credit claimed. These rules
apply to rehabilitated property placed in service after 1986.
Qualified reforestation expenses consist of up to $10,000 ($5,000 if married
filing separately) of the direct expenses of planting or replanting a forest or
woodlot held for timber or wood production. Direct expenses include site
preparation, seedlings, labor, and depreciation of equipment used. These are
the same expenses that qualify for amortization. Deductible operating costs,
all costs reimbursed through government cost-sharing programs, and all costs
associated with planting Christmas trees are excluded. The basis of any
depreciable reforestation expense must be reduced by 50 percent of IC claimed.
Unused Investment Credit
Investment credit carryovers from 1986 and earlier years may still be used
but only 65 percent of that left over from 1987 may be carried to later years.
Use Form 3800 to claim carryovers. Reforestation IC does not require the 35
percent reduction. Unused credit may be carried over for 15 years, and'if
unused credit still exists, one-half can be deducted in the 16th year.
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31
Recapture of Credit
Section 38 assets placed in service during 1985, the last year IC was
claimed by most taxpayers, and disposed of in 1992 were held for more than five
years and are no longer subject to IC recapture rules. Credit claimed more
recently under the transition property and rehabilitated building rules may
require recapture if early disposition occurs.
Energy Credit
A 10 percent credit on solar and geothermal energy equipment continues
through 6/30/92. Active solar devices for either space heating or water heating
would qualify under the solar category if put to original use by the taxpayer.
Other General Business Credits
Targeted Jobs Credit is available on qualified wages paid to employees who
began work before 7/1/92. The credit is equal to 40 percent of the.first $6,000
of qualified first-year wages paid to employees from targeted groups. Targeted
groups include handicapped individuals undergoing vocational training, an
individual receiving federal, state or local social services benefits, youth
enrolled in qualified cooperative education programs, and qualified
(economically disadvantaged) summer ·youth employees.
Low-Income Housing Credit is still available for low-income housing that is
constructed, rehabilitated or acquired before July I, 1992. The credit is
claimed ever a ten-year period, and annual allowances vary with new vs.
rehabilitated housing and changes in AFR. In June of 1992, the annual credit
was 8.76 percent for qualified new construction or rehabilitation, and 3.75
percent for subsidized construction and acquisition of existing housing.
Taxpayers qualifying for new low-income housing credit must enter into an
agreement to maintain the low-income status for 30 years.
Credit for Qualified Research Expenditures is available through June 30,
1992. The credit is 20 percent of the excess of qualified research expense for
the tax year over an average for the preceding four years. Qualified research
expenditures include costs of developing new products, processes, models,
software, formulas and technologies. Market and consumer research is excluded.
Disabled Access Credit
An eligible small business that pays or incurs expenses after November 5,
1990, for providing access to persons with disabilities is allowed a nonrefund­
able tax credit. The maximum amount of the credit is $5,000 per year (50 per­
cent of eligible expenses that exceed $250 but do not exceed $10,250). An
eligible business is one that for the preceding year did not have more than 30
full-time employees or did not have more than $1 million in gross receipts. An
employee is considered full-time if employed at least 30 hours per week for 20
or more calendar weeks in the preceding year.
The maximum credit limit applies to a partnership and to each partner. The
partnership allocates the credit among the partners. Each partner takes the
credit on his or her individual tax return. The maximum credit any individual
can claim from all sources is $5,000. A similar rule applies to an S corpora­
tion and its shareholders. To claim the credit, file Form 8826, Disabled Access
Credit. For more information, see Publication 907, Tax Information for Persons
with Handicaps or Disabilities.
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32
LIKE-KIND txCHANGES
Deferred Exchanges of Like-Kind Real Estate
Regulations issued in 1991 clarify the rules for delayed exchanges of real
estate under IRC Sec. 1031. These regulations make it possible to dispose of
one parcel of real estate (called the relinquished property) held for trade,
business, or investment purposes, and acquire another parcel of real estate to
be held for trade, business or investment purposes (replacement property) within
a limited period of time without paying tax on the gain from the disposition.
However, the proceeds from the disposition must not be paid to the seller. They
must be held in an escrow account where they are not available to the seller and
then used to acquire the replacement property. The person or firm who holds the
money must not have been the taxpayer's employee, attorney, accountant,
investment banker or broker, or real estate agent during the two-year period
prior to the transfer of the relinquished property. The taxpayer must not be in
actual or constructive receipt of the proceeds from the relinquished property.
However, it is legal for the seller to receive, at the end of the replacement
period, interest on the money that is placed in the escrow account. The new
regulations apply to transactions on or after June 10, 1991 and, under
transition rules, to some transactions on or after May 16, 1990 and before June
10, 1991. These regulations make it possible to have the tax-deferral benefits
of a "trade" without directly tradirig (exchanging) property with the owner of
the property the taxpayer wishes to acquire. One way to handle the transactions
is to deal with a "qualified intermediary."
The regulations are very specific about the hoops the taxpayer must jump
through in order for the transaction to be considered an exchange rather than a
sale. If the transaction does not comply with the rules, then the taxpayer will
have tax liability on the gain from the relinquished property. It is important
to keep in mind that the exchange process does not mean that the gain is tax
free. The process is one of tax deferral, and the tax will eventually be paid
when the taxpayer sells the replacement property. The only exception would be
that, if the taxpayer dies, the person who inherits the property will have a
stepped-up basis equal to the value of the property at the death of the taxpayer
and when the property is sold will escape paying tax on gain rolled over into
the replacement property.
The taxpayer has 45 days from the date of the sale (closing) of the
relinquished property to "identify" the replacement property and 180 days after
the sale to actually acquire the replacement property. However, if the due date
of the taxpayer's return is less than 180 days from the date of the sale of the
relinquished property, the taxpayer has only until the due date of the return to
acquire the replacement property. For example, any sale after October 17, 1992
would actually have less than 180 days in which to acquire the replacement
property because the 1992 return (if due April 15) will be due in less than 180
days. There is no fudging of the 45 and 180 days. Every day is counted,
including the date of sale, weekends, and holidays.
The fact that the relinquished property is not debt-free will not disqualify
a deferred exchange. However, debt on either the relinquished or replacement
property may complicate the mechanics of the exchange and reduce the amount of
gain that does not have to be recognized.
More than one piece of real estate can be used as replacement property. For
example, a farm could be exchanged for three rental properties. The replacement
property could have a higher fair market value than the relinquished property
but there are limits as to how much higher. If the replacement property has a
•
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33
lower value than the relinquished property. the transaction will not necessarily
be disqualified as an exchange, but there will be taxable gain.
Application to Transfers of Farm Real Estate. Tax deferral through a
deferred real estate exchange could be useful to owners of farm real estate in
at least two situations: (1) a farmer who wants to sell one farm and acquire
another without paying tax on the gain on the sale. and (2) a farmer who wishes
to leave farming and is willing to acquire other "like~kind" real estate. such
as an apartment house. motel. or commercial building, without paying tax on the
sale of the farm real estate. Many farmers who wish to leave farming do not
have the expertise to manage other types of real estate and. therefore. should
be extremely careful about exchanging their real estate for such property. In
some situations. the taxpayer could make the investment in such a way that it
would be managed by someone with sufficient expertise. This could mean placing
a substantial part of a farmer's retirement assets and income in the hands of
someone else. It would not be wise to do a real estate exchange to save the tax
on the gain unless the taxpayer is confident that the real estate received in
the exchange is a good inves~ment.
Anyone who is interested in a deferred exchange must be sure to get advice
from a knowledgeable attorney. accountant, or qualified intermediary.
Like-Kind Exchanges Between Related Parties
Exchanges made between related parties after July 10, 1989 are subject to
tax in some situations. The rules affect both direct and indirect exchanges.
As with other like~kind exchanges. when related parties exchange like-kind
property, no gain or loss is recognized (included in income). Under these
rules, if either party disposes of the property within two years after the
exchange. the exchange is disqualified from nonrecognition treatment. The gain
or loss must then be recognized as of the date of disposition of the property.
The two-year holding period begins on the date of the last transfer of property
which was part of the like-kind exchange.
Related parties. Under these rules. a related party includes a member of
your family (spouse. brother. sister. ancestor or lineal descendant) and a
corporation in which you have more than 50 percent ownership (plus others
described in Code Section 267(b). For exchanges after August 3. 1990, related
parties also include (1) a person and a partnership in which the person owns
more than 50 percent interest. and (2) two partnerships in which the same
person(s) own more than 50 percent interest (Code Section 707(b)(1).
Exceptions to the Related Party Rules. The following kinds of property
dispositions are excluded from the new limits on nontaxable like-kind exchanges
between related parties: (1) dispositions due to the death of either related
person. (2) involuntary conversions. or (3) exchanges or dispositions if it is
established to the satisfaction of the IRS that the main purpose is not the
avoidance of federal income tax.
Form 8824. Beginning in 1990. if you exchange property in a like~kind
transaction, you must file Form 8824. Like~Kind Exchanges, in addition to
Schedule D (Form 1040) or Form 4797. The instructions for each form explain how
to report the details of the exchange. Report the exchange even though no gain
or loss is recognized.
For more information on like-kind exchanges. see Like-Kind Exchanges in
Publication 544, Sales and Other Disposition of Assets.
.
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34
A REVIEV OF FARM BUSINESS PROPERTY SALES
The 1986 Tax Reform Act did not eliminate the distinction between gains from
sales of property used in the farm business eligible for capital gain treatment
and gains subject to recapture of depreciation. Therefore, it still is
important to understand the difference between these two types of gains. Form
4797 is used to report sales of property used in the farm business.
In 1991 and later, the maximum tax rate on capital gain is 28 percent.
Taxpayers in the 31 percent bracket will be taxed at 28 percent on capital gain
income. The calculation will be made on Schedule D.
The reporting of gains and losses on the disposition of property held for
use in the farm business continues to be a complicated but important phase of
farm tax reporting. Form 4797 must be used to report gains and losses on sales
of farm business property. Schedule D is used to accumulate capital gains and
losses. The treatment of gains and losses on disposition of property used in
the farm business can be better understood after a review of IRS classifications
for such property.
1. Section 1231 - Includes gains and losses on farm real estate and equipment
held at least one year, cattle and horses held 24 months, other livestock
held 12 months, casualty and theft losses and other involuntary conversions,
qualified sales of timber, and unharvested crops sold with farmland which
was held at least one year. There are instances, however, when gain on
livestock, equipment, land, buildings, and other improvements is treated
specifically under Section 1245, 1250, 1251, 1252, and 1255.
Note: For tax years beginning in 1986 and later, net Section 1231 gains are
treated as ordinary income to the extent of unrecaptured net Section 1231
losses for the five most recent prior years beginning with 1982. In other
words, a taxpayer that claimed a net Section 1231 loss on the 1987, 1988,
1989, 1990, or 1991 return and has a net Section 1231 gain for 1992, must
recapture the losses on the 1992 return. Losses are to be recaptured in the
order in which they occurred.
2.
Section 1245 - This is the depreciation recapture section. Farm machinery,
purchased breeding, dairy, draft and sporting livestock held for the
required period and sold at a gain are reported under this section. It also
applies to depreciation claimed on capitalized production costs and to
amounts which would have been capitalized if the taxpayer had not elected
out of capitalization. Gain will be ordinary income to the extent of
depreciation or cost recovery taken after 12/31/61 for equipment and
12/31/69 for livestock. Gain will also be ordinary income to the extent of
Section 179 expense deductions and the basis reduction required after 1982.
Tangible real property (except some Section 1250 buildings and their
structural components) used as an integral part of farming is 1245 property.
Single-purpose livestock and horticultural structures are 1245 property if
placed in service after 1980. Nonresidential 15-, 18-, and 19-year ACRS
property becomes 1245 property if fast recovery has been used. Other
tangible real property includes silos, storage structures, fences, paved
barnyards, orchards and vineyards.
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35
3. ' Section 1250 - Farm buildings and other depreciable real property held over
one year and sold at a gain are reported in this section unless the assets
are 1245 property. If other than straight line depreciation was used on
property placed in service before 1981, the gain to the extent of
depreciation claimed after 1969 that exceeds what would have been allowed
under straight line depreciation is recaptured as ordinary income. No
recapture takes place when only straight line depreciation has been used. A
taxpayer may shift such real property to straight line depreciation without
special consent.
If regular (fast) recovery has been used on ACRS IS, 18, and 19-year real
property other than residential property, all gain due to depreciation or
cost recovery will be ordinary income. In effect, this property becomes
1245 property. Again, no recapture of depreciation occurs when an ACRS
straight line option is used.
The law allows a different ACRS or MACRS option to be used on a substantial
improvement than on the original building. If fast recovery has been used
on either the building or a substantial improvement to it, gain will be
ordinary on the entire building to the extent of fast recovery, and any
remaining gain will be capital gain. For residential real estate, gain will
be ordinary only to the extent that fast recovery deductions exceed straight
line on 15-, 18-, and 19-year property.
4.
Section 1252 - Gain on the sale of land held less than 10 years will be part
ordinary and part capital gain when soil and water or land clearing expendi­
tures after December 31, 1969 have been expensed. If the land was held five
years or less, all soil and water or land clearing expenses taken will be
"recaptured" as ordinary gain. If the land was held more than five and less
than 10 years, part of the soil and water and land clearing expenses will be
recaptured. The percentages of soil and ,water conservation or land clearing
expenses subject to recapture during this time period are: 6th year after
acquisition of the land, 80 percent; 7th year, 60 percent; 8th year, 40 per­
cent; and 9th year, 20 percent.
Here is an illustration:
Farmland acquired, April I, 1985 cost
Soil and water expenses deducted
on 1986 tax return
Land was sold May 15, 1992 for
$100,000
$8,000
$130,000
During the time the land was owned, no capital improvements were made other
than the soil and water expenses, so the adjusted tax basis at time of sale
was $100,000. The gain of $30,000 would normally be all capital gain. The
land was held for seven years, so the gain is divided; $8,000 x .60 - $4,800
is ordinary gain and $30,000 - $4,800 - $25,200 qualifies as capital gain.
5.
Section 1255 ~ If government cost sharing payments for conservation have
been excluded from gross income under the provisions of Section 126, the
land improved with the payments will come under Section 1255 when sold. All
the excluded income will be recaptured as ordinary income if the land has
been held less than 10 years after the last government payment had been ex­
cluded. Between 10 and 20 years, the recapture is reduced 10 percent for
each additional year the land is held. There is no recapture after 20
years.
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36
Livestock Sales
The majority of livestock sales in New York State are animals that have been
held for dairy, breeding or sporting purposes. Income from such sales is always
reported on Form 4797. Dairy cows culled from the herd and cows sold for dairy
or breeding purposes are the most common of these sales. Sales of horses and
other livestock held for breeding, draft or sporting purposes .also go on 4797.
Income from livestock held primarily for sale is reported on Schedule F.
Receipts from the sale of "bob" veal calves, feeder livestock, slaughter
livestock, and dairy heifers raised for sale are entered on Schedule F, line 4.
Sales of livestock purchased for resale are entered on line 1 of Schedule F, and
for a cash basis farmer the purchase price is recovered in the year of sale on
line 2.
Breeding. Dairy. Draft or Sporting Livestock
Livestock held for breeding, dairy, draft or sporting purposes are
classified into two groups according to length of holding periods:
1. Cattle and horses held two years or more, and other breeding livestock held
one year or more. Animals in this group are 1231 livestock.
2.
Cattle and horses held less than two years, and other breeding livestock
held less than one year. These sales do not meet holding period
requirements.
Most dairy animals will meet the two-year holding period requirement. Major
exceptions are raised youngstock sold with a herd dispersal and the sale of cows
that were purchased less than two years prior to sale. The age of raised
animals sold will determine the length of the holding period. The date of
purchase is needed to determine how long purchased animals are held. The hold­
ing period begins the day after the animal is born or purchased and ends on the
date of disposition.
Reporting Sales of 1231 Livestock
Sales of 1231 livestock are entered in Part I or Part III of Form 4797.
Since Part III is for recapture, purchased 1231 livestock that produce a gain
upon sale will be entered in Part III where they become 1245 property. Sales of
raised animals on which costs were capitalized are also reported'in Part III as
are animals on which preproductive costs would have been capitalized if the
taxpayer had elected not to do so during the years when livestock were required
to be capitalized. Sales of raised 1231 livestock not subject to the
capitalization rules will be entered in Part I. This will include all raised
cattle and horses two years of age and older that are held for breeding, dairy,
draft or sporting purposes. All purchased 1231 livestock that result in a.loss
when sold are also entered in Part I.
Reporting Sales of Livestock Not Meeting Holding Period Requirements
Breeding, dairy, draft or sporting livestock that are not held for the
required period whether sold for a gain or loss will be entered in Part II 'of
4797. This will include raised cattle that are held for dairy or breeding but
sold before they reach two years of age and purchased cattle held for dairy or
breeding but held for less than two years.
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37
Use of 4797 and Schedule 'D by Farmers
All sales of farm business properties are reported on form 4797 to separate
1231 gain and loss from recapture of depreciation, cost recovery, Section 179
expense deduction and basis reduction. Casualty and theft gains and losses are
reported on 4684 and transferred to 4797.
If the 1231 gains and losses reported on 4797 result in a net gain, net 1231
losses reported in the prior five years must be recaptured as ordinary income by
transferring 1231 gain equal to the nonrecaptured losses to Part II. Any
remaining gain is transferred to Schedule D and combined with capital gain or
loss, if any, from disposition of capital assets. If the 1231 items result in a
net loss, the loss is combined with ordinary gains and losses on 4797 and then
transferred to Form 1040.
Summary of Reporting Most Common Farm Business Property Sales
Type of Farm Property
Tax Form and Section
1. Cattle and horses held for breeding, dairy, draft
or sporting purposes & held for 2 years or more;
plus other breeding or sporting livestock held for
at least one year.
a) Raised, preproductive costs not subject to
capitalization rules (1231 Property)
b) Purchased (and raised subject to capitalization
rules), sale results in gain (1245 Property)
c) Purchased (and raised subject to capitalization
rules), sale results in loss (1231 Property)
2. Livestock held for breeding, dairy, draft, & sporting
purposes but not held for the required period.
3. Livestock held for sale.
4197, Part I
4797, Part III
4797, Part I
4797, Part II
Schedule F, Part I
4. Machinery held for one year or more
a) Sale results in gain
b) Sale results in loss
4797, Part III
4797, Part I
5. Buildings, structures & other depreciable real
property held for one year or more
a) Sale results in gain
b) Sale results in loss
4797, Part III
4797, Part I
6. Farmland, held for one year or more, sold at a gain
a) Soil & water expenses were deducted or cost
sharing payments excluded
b) If 6a does not apply
7. Machinery, buildings, & farmland held for
less than one year
4797, Part III
4797, Part I
4797, Part II
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INSTALLHENTSALES
The installment method of reporting may still be used by nondealers for the
sale of real property or personal property (except depreciation recapture). It
continues to be a practical and useful method used in transferring farms to the
next generation. The installment method is required wben qualified property is
sold and at least one payment is received in the following tax year unless the
seller elects to report all the sale proceeds in the year of disposition.
Taxable income from installment sales is computed by multiplying the amount
received in any year by the gross profit ratio. The gross profit ratio is gross
profit (selling price minus basis) divided by contract price (selling price less
mortgage assumed by buyer). Form 6252 is used to report installment sales
income. IRS publication 225 contains a chapter on installment sales.
Depreciation Recapture
Recaptured depreciation does not qualify for the installment sale. For
installment sales made after 6/6/84, that portion of the gain attributed to
recaptured depreciation of Section 1245 and 1250 property must be excluded.
Section 179 expenses and capitalized expenditures also are treated as Section
1245 dispositions. The full amount of recaptured depreciation is reported as
ordinary income in the year of sale regardless of when the payments are
received.
Example: Frank Farmer sells his raised dairy cows, machinery and equipment
to son, Hank, for $180,000. The cows are valued at $80,000, the machinery at
$100,000. Hank will pay $30,000 down and $30,000 plus interest for five years.
Frank's machinery and equipment has an adjusted basis of $45,000; its original
basis was $125,000. The raised cows have zero basis. Frank's gain on the sale
of machinery and equipment is $55,000 ($100,000 - $45,000). The full $55,000 is
recaptured depreciation since prior year's depreciation, $80,000, is greater.
Frank must report $55,000 received from machinery in the year of sale. He will
report the $80,000 cattle sale gain on the installment method.
When the sale of 1245 and 1250 property produces gain in addition to that
which is recaptured, the amount of recaptured depreciation reported in the year
of sale is added to the property's basis for the purpose of computing the gross
profit ratio. This adjustment is critical in order to avoid double taxation of
installment payments.
Related Party Rules (I.R.C. Sec. 453)
The installment sale/resale rules should be reviewed ~nd understood before
farmers or other taxpayers agree to a sales contract. Gain will be triggered
for the initial seller when there is a second disposition by the initial buyer,
and the initial seller and buyer are closely related. The amount of gain
accelerated is the excess of the amount realized on the resale over the payments
made on the installment sale. Except for marketable securities, the resale
recapture rule will not generally apply if the second sale occurs two or more
years after the first sale and it can be shown that the transaction was not done
for the avoidance of federal income taxes. The two-year period will be extended
if the original purchaser's risk of loss was lessened by holding an option of
another person to buy the property, or by any short sale.
In no instance will the resale rule apply if the second sale is also an
installment sale where payments extend to or beyond the original installment
sale payments. Also exempt from the resale rule are dispositions (1) after the
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39
death of either the installment seller or buyer, (2) resulting from involuntary
conversions of the property (if initial sale occurred before threat or
imminence), (3) nonliquidating sales of stock to an issuing corporation.
Closely related person would include spouse, parent, children, and
grandchildren, but not brothers and sisters.
An additional resale rule prevents the use of the installment method for
sales of depreciable property between a taxpayer and his or her partnership or
corporation (50 percent ownership), and a taxpayer and a trust of which he or
she (or spouse) is a beneficiary. All payments from such a sale must be
reported as received in the first year and all gains are ordinary income (IRS
Sections 453(g) and 1239).
Rules for Dealers and Nondealers of Real Property (except farms)
All payments received from a dealer disposition of property must be reported
as received in the year of sale. A dealer disposition is: (1) any disposition
of real property held by the taxpayer for sale to customers in the ordinary
course of a trade or business; and (2) any disposition of personal property by a
taxpayer who regularly sells such property on the installment plan. A dealer
disposition does not exclude property used or produced in the trade or business
of farming from the installment method. The sale of time shares and residential
lots is allowed providing the "dealer" elects to pay interest on the tax
attributed to payments received in future years.
Installment sales of nonfarm real property used in the taxpayer's trade or
business, or held for the production of rental income, and sold for more than
$150.,000 are called "nondealer real property installment obligations" (NRPIOs).
When the balance of deferred payments on these sales made during the year
exceeds $5 million at the end of the year, interest must be paid on the deferred
income tax. When a nondealer sells real property used in a trade or business or
for the production of rental income for more than $150,000 and then uses the
installment sales contract as security for a loan, the loan proceeds received
are treated as installment payments received for tax purposes.
General Rules Still in Effect
Losses cannot be reported on the installment sale method. A partnership may
use the installment sale method of reporting gain on the sale of partnership
property even though an individual partner may realize a loss and recognize it
in the year of sale.
The capital gains rules in effect when an installment payment is received
and reported determines how the income is treated. However, a change or
increase in the capital gain holding period requirement during an installment
sale would not move a long-term gain to a short-term gain.
Property sold on a revolving credit plan may not be reported on the
installment method. All payments must be reported in the year of sale ..
Publicly traded stocks and securities may not be reported using the installment
method (TRA 1986).
A sale or exchange of an installment sale contract results in a gain or a
loss. The gain or loss is the difference between the "amount realized" and the
"basis" of the contract. The "amount realized" is the amount received by the
seller, including fair market value of property received instead of cash. The
"basis" of the contract is the same as the remaining basis of the underlying
property.
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40
A cancelation of all or part of an installment obligation is treated like a
sale or other disposition of the obligation except gain or loss is calculated as
the difference between the fair market value and the "basis" of the obligation
if the parties are unrelated (IRC Sections 453B(f)(1) and 453B(a)(2».
Unstated and Imputed Interest Rules
If the installment sale contract does not provide an adequate interest rate,
part of the principal payment must be treated as ordinary interest income by the
seller and an interest deduction by the buyer. The amount of interest that must
be recognized is called imputed interest.
Imputed interest rules applicable to certain debt instruments including
installment sales are covered under IRC Section 1274 and Section 483. There are
several special rules and numerous exceptions that complicate the understanding
and application of imputed interest rules. Following is our understanding of
t~e rules most applicable to farm business property installment sales.
1. All sales and exchanges after 6/30/85, where seller financing does not
exceed $2.8 million, must have an imputed interest rate of the lesser of 100
percent of the AFR or 9 percent (compounded semiannually). The acceptable
test or stated interest is the same.
2.
Sales exceeding $2.8 million are subject to an imputed interest rate equal
to 100 percent of the AFR. Sale-leaseback transactions of any amount are
subject to interest rates equal to 110 percent of AFR.
3. The sales or exchanges of land between related persons, (brothers, sisters,
spouse, ancestors or lineal descendants), mus't have a test or stated rate of
6 percent or interest will be imputed at 7 percent. This rule applies to
the first $500,000 of land between related people in one calendar year.
4. The imputed interest rules do not apply to the sale of personal use
property, annuities, patents, and any other sale that does not exceed
$3,000.
5.
Imputed as well as stated interest can be accounted for on the cash
accounting basis on sales of farms not exceeding $1 million and any other
installment sale not exceeding $250,000.
The AFR (applicable federal ~ate) is the 10wer.of the computed six-month
rate or the monthly rate. The monthly rate can be the current month's rate or
the lower of the two preceding months' rates.
The October 1992 monthly AFR was 3.78 percent (short term, not over three
years), 5.63 percent (mid term, three to nine years), 6.81 percent (long term,
over nine years). The monthly AFR is currently below the semiannual rate and
the October rates are lower than the two preceding months' rates.
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41
ALTERNATIVE MINIMUM TAX
The AMT resembles a separate but parallel tax system. Separate calculations
of many types of income and deductions including depreciation are required for
many taxpayers. AMT may be created by either "adjustments" or "preferences".
In either category, there are "exclusions" and "deferrals". Deferrals create a
postponement of tax benefits rather than permanent removal and result in an AMT
credit (Form 8801) in future years. Exclusions will never create an AMT credit.
AMI Rate
and Exemption Phaseout
The AMT flat rate is 24 percent. The basic exemptions remain unchanged
because they are not indexed. An exemption phaseout reduces the exemption at a
rate of 25 percent of AMT income exceeding specific levels, as shown in the
table below. If the taxpayer's AMTI exceeds the exemption, he or she will have
a calculated AMT but will pay AMT only if it exceeds the regular tax. See later
section for definition of regular tax for this purpose.
Filing Status
Alternative Minimum Tax Exemption and Phaseout
Maximum
AMTI
Exemption
Phaseout Range
Joint & qualifying widow(er)
Single & heads of household
Married filing separately
$40,000
30,000
20,000
$150,000-310,000
112,500-232,500
75,000-155,000
Phaseout
Percent
25
25
25
Alternative Minimum Taxable Income
AMTI is calculated by starting with line 35 on 1040 which is before
subtracting the personal exemptions. This would be negative on Form 6251 when
line 32 less line 34 of 1040 is negative, even though the entry on line 35 of
1040 is zero. Any NOL carryforward used in calculating the regular tax is
added. Itemized deductions disallowed on Schedule A for higher income taxpayers
are included on line 3 of 6251.
Here are the adjustments that must be added to taxable income. The first
category contains adjustments treated as "exclusions". AMT due to exclusions is
not eligible for a credit against the following year's regular tax. The
remaining adjustments are deferral items (2 through 11 in the list below) and
are used in computing AMT credit in future years.
1. Exclusion items: Standard deduction or certain itemized deductions from
Schedule A, including most medical deductions, miscellaneous deductions
subject to the 2 percent rule, state and local income taxes, and interest
adjustments. Interest adjustments include the difference between qualified
housing interest and qualified residence interest, interest income on
private activity bonds that are exempt from regular tax, and a net
investment income adjustment which could be either positive or negative.
These are lines 5a through g on Form 6251.
2. Depreciation on personal property placed in service after 1986 that exceeds
150 percent declining balance using alternative MACRS years of life. There
are some exceptions, including property depreciated under the unit-of­
production method, and property subject to transition rules for MACRS. The
depreciation adjustment is the net difference between accelerated MACRS
depreciation and that allowed for AMT. If straight line is used for regular
tax, it must be used for AMT. The Section 179 expensing election deduction
is allowed in calculating AMTI.
­
,.
42
3.
The difference between the regular tax deduction for circulation and
research and experimental expenditures and the allowable AMT deduction
based on 10-year amortization.
4.
The difference between the regular tax deduction for mining exploration and
development costs and 10-year amortization allowed for AMTI.
5.
Incomplete long-term contract costs calculated using the completed contract
method less those using the percentage of completion method.
6.
Cost recovery for pollution control facilities amortized over 60 months
less alternative MACRS allowed for AMTI.
7.
Entire gain from installment sales of property held primarily for sale in
the ordinary course of the business. Dealer installment sales are not an
adjustment because these cannot be reported on an installment basis for
regular tax purposes. Exceptions include property used in farming and
personal property not used in a trade or business.
8.
The difference (due to different depreciation allowances) between the
regular income tax gain or loss and the AMTI gain or loss when there is a
taxable exchange. Any AMT adjustment from the exercise of stock options
after 12/31/87 also is included here.
9.
A difference in allowed losses including losses from all tax shelter farm
activities. Losses cannot be offset by gains.
10. The difference between passive activity losses allowed for AMTI and those
allowed for regular tax.
11. AMTI from estates and trusts.
Preference Items - The first three are treated as "exclusions"; 4 and 5 are
"deferral items".
1. The appreciated portion of capital gain gifts, the difference between the
property's fair market value and its basis, claimed under charitable
contributions. Charitable contributions of appreciated tangible personal
property made prior to July 1, 1992 do not create a tax preference.
2. Tax-exempt interest from private activity bonds.
3. The excess of the tax depletion allowance over the adjusted basis of the
property.
4. Accelerated depreciation of real and leased personal property placed in
service before 1987 and amortization of certified pollution control
facilities placed in service before 1987.
5.
Intangible drilling costs.
AMI Net Operating Loss Deduction
The deduction of AMT NOL is the last step in calculating alternative minimum
taxable income. The AMT net operating loss is limited to 90 percent of AMTI and
is calculated and deducted after all adjustments and preferences have been added
in. The AMT NOL is calculated the same as the regular NOL except:
1. The regular tax NOL is adjusted to reflect the adjustments required by the
AMT rules.
2. The AMT NOL is reduced by the preference items that increased the regular
tax NOL.
•
. ..
43
Schedule A (Form 1045) can be used to calculate the AMT NOL providing the
above exceptions are included.
Tentative Minimum Tax
The minimum tax exemption reduced by the 25 percent phaseout is subtracted
from AMTI before the 24 percent rate is applied. Then the AMT foreign tax
credit is subtracted to arrive at tentative minimum tax. A taxpayer who has
regular foreign tax credit will compute AMT foreign tax credit in much the same
manner, although the amount that can be used to reduce AMT is limited.
Alternative Minimum Tax and Credits
Tentative minimum tax less the regular income tax equals AMT. Regular
income tax excludes several miscellaneous taxes, such as the tax on lump-sum
distributions. Regular income tax is reduced by the foreign tax credit (but not
business tax credits) before it is entereq on line 21 Form 6251.
Foreign tax credit is the only credit allowed in the calculation of AMT.
The other credits, including investment credit, can be carried forward to the
extent they do not provide a tax benefit because of the AMT.
A taxpayer may not use business credits to reduce regular tax below AMT.
This general business credit limitation is calculated on Form 3800 rather than
on 6251.
Who Must File Test
Many more taxpayers are required to file Form 6251 than have an AMT
liability. Form 6251 must be filed if the taxpayer is liable for AMT or if line
9 (TI plus all adjustments and preference items) is greater than the exemption
on line 12 and there are adjustments or preferences other than those on lines 5a
through g.
The AMI Credit
The AMT credit allows a taxpayer to reduce regular income tax to the extent
that deferral adjustments and preferences created AMT liability in previous
years. The AMT credit also includes any credit for producing fuel from a
nonconventiona1 source that was disallowed in an earlier year due to AMT. The
credit means that the taxpayer, in the long run, will not pay AMT on the
deferral items.
Part I of Form 8801 is used to compute the AMT that would have been paid in
the previous year on the exclusion items if there had been no deferral items.
This requires the computation of a "minimum tax credit net operating loss
deduction" (MTCNOLD), which is calculated like the AMT NOL except that only the
exclusion adjustments and preferences ,are included. It also requires
computation of the minimum tax foreign tax credit on the exclusion items.
Part II of 8801 is used to compute the allowable minimum tax credit and the
AMI credit carryforward. The computation includes unallowed credit for
producing fuel from a nonconventiona1 source.
-
44
NET OPERATING LOSSES
Farmers and nonfarm taxpayers who sustain a net operating loss in 1992 may
carry it back to recover taxes paid in former years or carry it forward to
reduce taxes to be paid in future years. The net operating loss is the
. taxpayer's business loss for the year modified to remove some of the other tax
benefits (IRS Section 172).
The calculation of a net operating loss, and its application to recover
taxes in another year, is a complex process governed by strict rules of
procedure. The 1992 Illinois Farm Income Tax Workbook contains an excellent NOL
section including illustrations and worksheets. IRS Pub. 536 covers NOLs.
Following are general rules and guidelines to consider before computing an NOL.
A net farm loss on Schedule F or net business loss on Schedule C is not
equal to a net operating loss. The NOL is usually less than, but it could be
greater than, the net business loss. Business losses must be combined with all
other income, losses, and deductions on 1040 to determine if there is a net
operating loss. The NOL is carried back or forward to other tax years, but
sometimes not all of it will be used to reduce taxable income in those years.
The opportunities and consequences of carrying an NOL back should always be
considered first. If the NOL is carried back, it must be carried back three
years, then to each succeeding year, if necessary, to use it up. A 1992 NOL
would be first carried back to 1989, then to 1990, 1991, and then forward to
1993 and in order to 2007 if necessary. The carryforward provision is 15 years.
A taxpayer may elect to forego the entire carryback period. The election must
be made by the due date for the return of the year the NOL occurred by attaching
a statement to the return. It cannot be made on an ammended return. Once the
election is made, it is irrevocable for that tax year. If the election is not
made by the applicable date, the NOL will be considered absorbed as if it had
been carried back, even if it had not been claimed in a carryback year. If
there is more than one operating loss to be carried to the same tax year, the
loss from the earliest year is applied first.
Reasons to forego the carryback period include low income during the
carryback period and the investment tax credit recomputation that would be
required.
In making a claim for an NOL, a concise statement showing its computation
must be filed with the return for the year the NOL is used. For a carryback
year, the statement can be filed with a Form 1045 or 1040X. Form 1045 Cor Form
1139 for a corporation) must be filed within one year after the close of the NOL
year. Form 1040X may be filed within three years of due date for the NOL year
return. Schedules A and B (Form 1045) are used to compute the NOL and NOL
carryovers.
The NOL is llQ! considered when calculating net earnings from self-employment
for the year to which the NOL is carried.
A partnership or S corporation is not allowed to claim an NOL, but each
partner or shareholder may use his or her share of the business NOL to determine
hisfher individual loss. A regular corporation's NOL is handled similarly to an
individual's but the modifications and adjustments are calculated differently.
45
Step One - How to Calculate a Net Operating Loss
Example: B.L. Farmer shows a $34,300 loss on Schedule F. The farm loss is
combined with other income on Form 1040 to show an adjusted gross income of
($16,400). After the standard deduction of $6,000 and four exemptions ($9,200),
taxable income is ($31,600). Actually, the entry on line 37 would be zero.
Income:
Part-time salary
Interest income
Dividends
Capital gain (livestock sales) from Schedule D (1040)
Supplemental gains (Form 4797)
Farm loss
Adjusted Gross Income
$
1,000
600
400
15,000
900
(34.300)
$(16,400)
No net operating loss was carried forward to 1992 from a prior year.
The illustration presented here follows the 1045 Schedule A format. Lines 1
through 3 of Schedule A compute taxable income (which would be zero on line 37
of 1040 but actually must be negative if there is to be any chance of an NOL).
1. Adjusted gross income
2. Deductions
a. Standard or itemized deductions
b. Exemptions
c. a + b
3. Combine lines 1 and 2c
(16,400)
6,000
9,200
(15,200)
(31,600)
Adjustments
4. Exemptions from 2b (these are not
allowed in calculating NOL)
9,200
Lines 5 through 22 are designed to apply two rules used
in computing an NOL:
(1) nonbusiness deductions are
allowed only to the extent of nonbusiness income, and
(2) capital losses are allowed only to the extent of
capital gains. The two rules interact w~th each other.
5. Nonbusiness capital losses (enter as a
positive number)
6. Nonbusiness capital gains
7. If line 5 is more than line 6, enter
the difference; otherwise, enter zero
8. If line 6 is more than line 5, enter
the difference; otherwise, enter zero
o
o
o
o
Note: Lines 5 through 8 determine whether nonbusiness
capital losses exceed nonbusiness capital gains (Rule
2).
9. Nonbusiness deductions
10. Nonbusiness income (other than capital
gains)
11. Add lines 8 and 10
12. If line 9 is more than line II, enter
the difference; otherwise, enter zero
­..
6,000
-1,000
1,000
5,000
46
Note: The purpose of lines 9 through 12 is to determine
whether nonbusiness deductions exceed nonbusiness income
(other than capital gains) (Rule 1).
13. If line 11 is more than line 9, enter
difference (but do not enter more than
line 8); otherwise, enter zero
o
Note: Line 13 determines whether nonbusiness income is
more than nonbusiness deductions (Rule 1).
14. Business capital losses (enter as a
positive number)
15. Business capital gains
16. Add lines 13 and 15
17. If line 14 is more than line 16, enter
difference; otherwise, enter zero
o
15,000
15,000
o
Note: The purpose of lines 14 through 17 is to
determine whether business capital losses exceed
business capital gains (Rule 2).
18. Add lines 7 and 17.
19. Enter loss, if any from line 17 of Schedule D (Form
1040). Enter as a positive number. (If you do not
have a loss on that line, skip lines 19-21 and enter
on line 22 the amount from line 18.)
20. Enter the loss from line 18 of Schedule D (Form 1040).
Enter as a positive number.
21. Subtract line 20 from line 19.
22. Subtract line 21 from line 18.
o
o
o
o
o
Note: Lines 18 through 22 determine whether total
capital losses exceed total capital gains (Rule 2).
23. Net operating losses from other years (enter as a
positive number).
o
Note: Line 23 removes NOLs from other years that were
used in computing this year's AGI.
24. Add lines 4, 12, 22 and 23
.14,200
Note: This is the total of items that will be used to
reduce the NOL, i.e., B.L. gets only a $1,000 benefit
from his standard deductions and exemptions, or the
amount that offsets nonbusiness income.
25. Net Operating Loss. Combine lines
3 and 24. If this amount is negative,
it is the NOL for the year.
While B.L.'s Schedule F loss was $34,300, the NOL was $17,400.
(17,400)
­
47
Step Two - How to Carry 8ack the NOL
The full NOL must be carried to the earliest eligible year. If the NOL is
equal to or less than the AGI less the standard deduction (or itemized
deductions recomputed as in rules 4 and 5 below) plus exemptions for that year,
deduct the full NOL as in Step Three. However, if the'NOL is greater than the
AGI less the standard deduction (or itemized deductions as recomputed) plus ex­
emptions, the NOL must be compared to modified taxable income to determine how
much of the available NOL may be used and how much is carried over to the next
year.
Modified taxable income is taxable income for that eligible year adjusted by
the rules below. Schedule 8 of 1045 is used to make the modifications. The
starting point is taxable income for the eligible year which includes NOL
carrybacks or carryforwards from years before the year from which the current
carryback comes.
1.
The net capital loss deduction is not allowed.
income of the carryback year.
It must be added to taxable
2.
If there was a capital loss deduction in the carryback year, there are
several adjustments to adjusted gross income:
a. The special allowance for passive activity losses from rental real
estate activities;
b. Taxable social security benefits;
c. IRA deductions;
d. Excludable savings bond interest.
In making these adjustments, the adjusted gross income is first increased
by the net capital loss deduction: The NOL carryback is not included. The
adjustment for each item is made in the order listed above. In computing
each adjustment, adjusted gross income is increased by the 'previous
adjustments.
3.
Modified taxable income must be computed before any NOL deduction from the
loss year and all later years.
4.
Itemized deductions based on or limited by a percentage of AGI must be
recomputed based on modified AGI. Charitable contributions have a set of
rules different from those used for other itemized deductions. Use lines 9
through 33 on Schedule 8 of 1045 to recompute itemized deductions.
5.
The charitable deduction must be recomputed using a limit based on an AGI
modified by rules 1, 2, 3, and 4 and by removing NOL carrybacks.
6.
Personal exemptions are not allowed.
Example: If 8.L. Farmer carries his 1992 NOL of $17,400 back to 1989 where
he had an adjusted gross income of $32,800 and a taxable income of $19,600, the
full NOL will be used. If 1989 taxable income had been less than $17,400, the
adjustments listed above would have been applied to determine the modified
taxable income. If 1989 modified taxable income was $10,000, 8.L. would deduct
only $10,000 of his 1992 NOL on the 1989 return.
•
48
Step Three - Determining Amount of Refund
In determining the amount of refund due when a carryback is made to a-prior
year, the taxable income for that year must be recomputed. After the NOL is
deducted, itemized deductions based on a percentage of AGI must be recomputed.
The income tax liability for that year, alternative minimum tax, and tax credits
claimed must be refigured. ­
Example:
B.L. Farmer determines his 1989 refund as follows:
Adjusted gross income on 1989 return
Less: 1992 NOL
Adjusted gross after carryback
Minus: Standard deduction
Exemptions
Taxable income after carryback
Tax liability on $2,200 after carryback
Tax liability on 1989 return
Tax paid on 1989 return (net of $1,000
Ie)
Less tax liability after carryback
Refund on 1989 return
$32,800
-17.400
$15,400
- 5,200
- 8.000
$ 2,200
332
$ 2,944
$ 1,944
332
$ 1,612
B.L. Farmer paid no AMT in 1989,but $1,000 of investment credit was used to
reduce the 1989 tax liability. If there had been no investment credit used in
1989, the tax paid would have been $2,944 and B.L. would be eligible for a
$2,612 refund. Since only $1,944 of income tax was actually paid in 1989, the
1989 refund will be $1,944 - 332 - $1,612. However, the $1,000 investment
credit originally used is freed by the NOL and is now an unused investment
credit balance of $1,000 that may be carried forward.
Step Four - Carry Over Unused NOL to Subsequent Year
Under the alternative assumption, B,L. Farmer's 1989 modified taxable income
was $10,000, which limited 1992 NOL used in 1989 to $10,000. The amount of
unused NOL, $7,400, is carried over to the 1990 return.
•
49
PASSIVE ACTIVITY LOSSES
Section 469, added to the IRC by TRA of 1986, placed significant limits on
the use of tax losses to shelter business and investment income as well as
salary and wage income. The IRS has issued hundreds of pages of temporary and
proposed regulations relative to passive losses (1.469-0T through 5T and 11T).
Reg. 1.469-4T has been superseded by Proposed Reg. 1.1469-4.
The Rule
Passive activity losses (and credits) can only be used to offset passive
activity income. Passive activity loss is defined as the excess of the
aggregate losses from all passive activities over the aggregate income from all
passive activities. Losses from passive activities cannot be deducted against
any other income. Excess losses can be carried forward and used to reduce
future passive activity income. In 1990 and later, 100 percent of passive
losses are disallowed.
A passive activity includes:
1. Any trade or business in which the taxpayer does not materially participate.
Working interests in oil and gas property are excluded.
2. Any rental activity regardless of whether the taxpayer materially
participates (see $25,000 loss allowance).
3. Any limited partnership interest.
Material participation occurs when the taxpayer (or the spouse) is involved
in the operation of the activity on a regular, continuous, and substantial
basis. Regulations at Sec. 1.469-5T list seven tests for material
participation. Meeting anyone of these means that the taxpayer materially
participates in the activity. A farmer who receives self-employment income will
generally be treated as materially participating even if shefhe contributes no
physical labor.
Disposal of the entire interest in a passive activity in a taxable
disposition means that losses, including nondeducted losses from prior years
from that activity, can be deducted against any kind of income.
Aggregation and Separation of Activities
Regulation 1.469-4T issued in May 1989 requires separation of activities
into four classes: (1) Oil and Gas, (2) Rental, (3) Professional Service, and
(4) Other trade or business. This regulation is long and complicated.
Proposed Reg. 1.469-4, which applies to tax years ending after May 10, 1992,
is intended to provide simple rules for determining a taxpayer's activities for
passive loss purposes. This will replace Reg. 1.469-4T and'adopts a facts-and­
circumstances approach to identifying a taxpayer's activities. The Commissioner
has a right to redetermine a taxpayer's activities. For the tax year that
includes May 10, 1992, the taxpayer may apply the 1.469-4T rules rather than
Proposed Reg. 1.469-4. The Proposed Reg. provides that the taxpayer may, under
some circumstances, dispose of part of an activity and treat that part as a
separate activity.
­.
50
Election to Separate
Under 1.469-4T(0), a taxpayer may make a permanent election to separate
undertakings which otherwise would be combined into a single activity. For
interests held in 1989, the election must have been made with the 1989 return.
For interests acquired in years after 1989, the election must be made with the
return for the year in which the taxpayer acquires interest in the activity.
Real Estate Rental
A special real estate rental rule allows an individual taxpayer (natural
person) to use real estate rental activity losses in which he/she actively
participates to offset up to $25,000 of nonpassive income. The $25,000
exemption is reduced by 50 percent of the amount by which the taxpayer's
modified AGI exceeds $100,000. There are special rules for married taxpayers
filing separate returns. Active participation only requites participation in
major management decision making and will be much less difficult to establish
than material participation. Major management decisions include approving new
tenants, selecting rental terms, and approving repairs and capital expenditures.
An individual whose interest in the rental activity is less than 10 percent will
not qualify as actively participating.
Crop Share Farm Leases
In the past, "knowledgeable tax experts" have stated. that crop share leases
of farms did not qualify under the real estate rental active participation
rules. The landlords typically did not "materially participate" in the
operation of the farm and, if their share of the farm income when combined with
their expenses produced a loss, it was a passive loss. These experts have
changed their position and now believe. that crop share leases where the landlord
actively participates qualify as rental activities so that up to $25,000 of
losses could be used to offset nonpassive income. Practitioner~ who have not
taken advantage of this interpretation for their clients in previous years may
want to consider filing amended returns for open years.
Farmers Who Become Landlords
A farmer who alters the operation of the business by entering into an
arrangement whereby the real estate is rented to another person or entity could
inadvertently run into the passive loss rules and be limited on deduction of
rental losses. This could occur if the real estate owner entered a partnership
or corporation to operate the farm and rented the real estate to that entity.
It could also occur if he quit farming and rented the real estate to another
person or entity. The situation could arise where the real estate expenses such
as taxes, interest and depreciation were greater than the rental income. If the
owner "actively participates", losses of up to $25,000 could be deducted against
other income (assuming modified AGI under $100,000). However, if the owner did
not actively participate, no losses could be deducted.
Forestry Operations
A forestry or woodlot operation where the owner materially participates
should be able to deduct losses, that is, the excess of expenses over income
from sales of timber (assuming the operation is not determined to be a hobby).
However, if there is no evidence of material participation (someone else manages
the property or it is not really managed at all), losses could be determined to
be passive and the losses disallowed.
.
51
INFORMATIONAL RETURNS
Some of the most important of the 14 or more informational returns are
reviewed here.
Provisions
1099-MISC - Must be filed by any person engaged in a trade or business, on
each nonemployee paid $600 or more for services performed during the year.
Rental payments, royalties, prizes, awards, and fishing boat proceeds must also
be reported when one individual receives $600 or more. Payments made for
nonbusiness services and to corporations are excluded. When payments of $600 or
more are made to the same individual for independent services and merchandise,
payments for the merchandise can be excluded only if the contract and bill
clearly show that a fixed and determinable amount was for merchandise.
Farmers must include payments made to noncorporate independent contractors,
attorneys, accountants, veterinarians, crop sprayers, and repair shops. Pay­
ments made for feed, seed, fuel, supplies, and other merchandise are excluded.
Health plan participants must report aggregated payments of $600 or more to
physicians and health care providers.
1099-G - Report of agricultural program payments, discharge of indebtedness
by federal government, state tax refunds, and unemployment compensation.
1099-INT- Statement for Recipients of Interest Income. Filed by bankers and
financial institutions when interest paid or credited to individual taxpayers is
$10 or more, and by any taxpayer if in the course of a trade or business $600 Or
more of interest is paid to a noncorporate recipient.
1099-PATR - Taxable Distributions Received from Cooperatives.
for each patron receiving $10 or more.
Must be filed
1099-S - Report payments of timber royalties under "pay-as-cut" contracts
and gross proceeds from the sale of most real estate transactions.
8300 - Recipient reports cash transactions of over $10,000 received in the
course of a trade or business, within one year in one lump sum or in separate
payments, from the same buyer or agent, in a single or related transaction.
Cash includes all currency and specific monetary instruments with a value of
less than $10,000 (cashier's checks, bank drafts, traveler's checks, and money
orders). The report must be filed within 15 days after receiving $10,000.
8308 - Partnership reports the sales or exchange of partnership "interest
involving unrealized receivables or" substantially appreciated inventory items.
8809 - Request extension of time to file informational returns with IRS.
Filing Dates and Penalties
The 1099s must be furnished to the person named on the return on or before
January 31 and to the IRS with Form 1096 (Annual Summary and Transmittal) on or
before March 1. There is a single $50 per return penalty for failure to file
correct and timely information returns. There is no penalty if failure is due
to reasonable cause. The penalty is reduced when the failure is corrected on or
before August 1. The penalty applies to each failure, and there-is a total
penalty cap for small businesses. If failure to file/include correct
information is due to intentional disregard of the regulations, the penalty is
$100 or 10 percent of the amount reported on the information return, whichever
is greater. The penalty for intentional disregard of reporting cash payments
over $10,000 received is now the greater of $25,000 or the amount of the cash
payment up to $100,000.
­
52
THE SOCIAL SECURITY TAX SITUATION AND MANAGEMENT OPPORTUNITIES
Annual increases in the earnings subject to social security (FICA) and self­
employment taxes continue to place a high priority on exploring opportunities to
reduce the burden of these taxes through wise tax management.
The Current Tax Burden
The social security earnings base increased to $55,500 for 1992, and base
was raised to $130,200 for the hospital insurance or medicare tax. FICA and
self-employment tax rates remain the same as in 1991. The total rate is divided
into two components representing the social security and medicare tax. The
maximum 1992 FICA tax is $5,328.90 (employer's share), up only $205.60, or 4
percent, since 1991. The maximum self-employment tax is $10,657.80 in 1992, up
$411.20 or 4 percent from 1991.
Social Security Tax Table
Year
1991
1992
1993
1
Earnings Base
Soc. Sec.
Medicare
$53,400
$125,000
$55,500
$130,200
FICA Rate %1
Soc. Sec.
Medicare
6.20
1.45
6.20
1.45
Self-Employment Rate %
Soc. Sec.
Medicare
12.40
2.90
12.40
2.90
Paid by both employer and employee.
Separate social security and medicare tax withholding tables are used by
employers. Forms 941, 942 and 943 require that social security and medicare
taxes be reported separately. The self-employment tax on long Schedule SE is
also computed separately.
Two Deductions
1.
Self-employed taxpayers deduct from taxable income on line 25, Form 1040,
one-half of self-employment taxes that can be attributed to a trade or
business. The rationale for this tax deduction is that employees do not
pay income taxes on the one-half of FICA taxes paid by their employer.
2.
Self-employed taxpayers deduct 7.65 percent from self-employment income
when computing net earnings from self-employment. This is achieved by
multiplying total profit (or loss) from Schedules C and/or F by 0.9235 on
Schedule SE. This adjustment is made before applying the social security
and medicare tax earnings base. Taxpayers repor~ing less than $55,500 of
self-employment income will receive the greatest benefit from the
deduction. This adjustment is allowed because employees do not pay social
security tax on the value of their employer's share of FICA tax.
Farmer's Optional Method
Low-income farmers may still use the optional method and report up to $1,600
of self-employment income when net farm income is less than $1,733. Self­
employed nonfarmers have a similar option. Self-employed workers should give
serious consideration to using the optional method if they are not currently
insured under the social security system.
,
•
53
Wages Paid to Spouse. Children and Farm Yorkers
Farm employers must pay social security on their employees if they pay wages
of more than $2,500 to all agricultural labor during the year. Any employee
receiving $150 or more of wages is subject to social security even if the
employer's total annual payroll is less than $2,500. All employees are covered
if the annual payroll exceeds $2,500. Seasonal farm piece work labor is exempt
from the $2,500 rule providing the employee is a hand harvester, commutes to the
job daily from a permanent residence, and was employed in agriculture for less
than 13 weeks in the prior year. Seasonal farm piece .work labor is subject to
the $150 rule. The $150 test is applied separately by each employer.
Wages earned by a person employed in a trade or business by his or her
spouse have been subject to social security coverage and FICA taxes since
January 1, 1988. Wages paid to individuals 18 years old and over working for
their parent(s) in a trade or business are also subject to FICA taxes. Children
under age 18 working for a parent's partnership, corporation, or estate are
covered by social security. Wages paid by a parent to a child for domestic
service in the horne are not covered until the child reaches 21.
Noncash Payments to Employees
Precaution: Although IRS code and regulations exempt in-kind or noncash
agricultural wages from FICA, FUTA, and income tax withholding, use of the
exemption has come under Congressional and IRS scrutiny. The practice may be
short-lived.
Social security tax does not have to be paid on payments that are other than
cash for agricultural labor. So, wage payments to agricultural labor in crops,
livestock and other commodities are not subject to FICA tax, and as they are
payments received as employees, they are not subject to self-employment tax.
This technique could be used for paying the spouse, for children who are working
on the farm but are over age 18, or for other agricultural labor. When payments
are made in kind and not in cash, the following conditions should be met: (1)
physical possession of the crop or commodity should be given to the employee,
(2) pre-arranged sales should be avoided, and (3) the employees should be
instructed to decide the time, place, and terms of the sale rather than simply
adding them to the employer's marketing activity [Revenue Ruling 79-207].
In a private letter ruling, IRS said the payment of wages with milk was not
subject to the FICA tax, even though the employee chose the same milk market and
milk hauler as the employer. IRS has also allowed wages to be paid with grain,
calves and the services provided for livestock care. Not all of these types of
rulings have favored the taxpayer. If the IRS disallows a noncash payment, the
employer will have to pay the full FICA tax.
When farm commodities are used to pay employees for services, their employer
must report the fair market value of the commodity on the date of payment as
Schedule F income. The same amount is claimed by the employer as a labor
expense on Schedule F, but it is not reported as a cash wage on Form 943 or the
employee's W-2. It is included as other compensation in box 10 of Form W-2.
Employees who receive commodities in lieu of wages must report their initial
market value as wage income. When the commodities are sold, the sale price is
reported on Schedule D less the basis which is the initial market value plus
storage and marketing expenses.
­
54
It is important to document all the details.of the employment arrangement
when noncash wages are paid and to be consistent with-the treatment of the
transaction on the employer's and employee's tax returns. A written employment
contract that states the rate and form of payment for services is recommended.
When the employee sells the commodity, the proceeds from the sale should be
deposited in the employee's separate account.
In summary, the employee should be given complete possession and control,
and the sale or other disposition of the "in kind" payment should be at the
discretion of the employee and independent of that of the employer.
Taxation of Social Security Benefits
There is no change in the rules that include social security and railroad
retirement benefits in gross income. The inclusion is limited to the lessor of
(1) one-half of the benefits received, or (2) one-half of the excess of the sum
of the taxpayer's adjusted gross income, interest on tax-exempt obligations, and
half of the social security benefits over the base amount. ($32,000 for persons
filing jointly, $0 for married persons filing separately but living together,
and $25,000 for all others.) Medicare payments are excluded from gross income.
Example: M. and P. Retiree received $15,200 in 1992 social security
benefits, $3,000 of tax exempt interest, and their AGI (joint return) was
$26,400 (excluding social security).
Calculation: $26,400 + $3,000 + $7,600 (one-half social security) - $37,000
$37,000 - $32,000 (base amount) - $5,000 + 2 - $2,500.
M. and P. include $2,500 since it is less than $7,600.
Reduction of Benefits
When a person's wage and self-employment .earnings exceed the earnings limit,
social security benefits of the working beneficiary and dependents are reduced
by a percentage of the excess earnings. In 1992 the annual earnings limit for
those less than age 65 is $7,440, and for those age 65 to 70 it is $10,200. The
reduction of benefits is one-half of excess earnings when less than age 65 and
one-third of excess earnings when age 65 to 70.
Rental Income and Deductions (I.R.C. l402(a)(1)
Generally, rental income from real estate and from personal property leased
with the real estate (including crop share rents) is reported on Sch. E and not
included in net earnings from self-employment. Crop and livestock share rents
are reported on 4835 and flow through to Sch. E. There are two exceptions.
1.
Rentals received in the course of the trade or business of a real estate
dealer are included in net earnings from self-employment.
2.
Production of agricultural or horticultural commodities. Income derived by
the owner or tenant of land is included in net earnings from se1f­
employment if:
a.
there is an arrangement between
which the other person produces
commodities on the land and the
materially in the production or
such commodities, and/or
the taxpayer and another person under
agricultural or horticultural
taxpayer is required to participate
the management of the production of
-
55
b.
there is material participation by the taxpayer with respect to the
agricultural or horticultural commodity.
According to Schedule E instructions, income and expenses from the rental of
personal property (not leased with real estate) is reported on Schedule C or C­
EZ. Net profit from Schedule C is included in self-employment income.
Paying Rent to a Spouse
It is common for husbands and wives to own farm real estate as joint
tenants, for the husband to operate the farm as the sole proprietor and to pay
self-employment tax on the entire farm "net profit." Paying rent to a spouse
for use of the property he or she owns reduces self-employment tax.
Although Rev. Rul. 74-209, 1974-1 allows a husband to deduct rent paid to
his wife as a joint owner of business property equal to one-half its fair rental
value, recent IRS rulings and opinion have qualified that ruling. In Ltr. Rul.
9206008, the IRS stated that "in order for the rental arrangement to be
recognized for federal purposes, the action of (H and W) with respect to the
sharing of the economic burden of, and claiming deductions for, expenses related
to the property must be consistent with the assertion that (W) is conducting a
separate rental activity." Taking the rental deduction on Schedule F was
disallowed primarily for using inconsistent methods of deducting the ownership
costs of the property. IRS is also utilizing Code Sections 482 and 162 to
prevent tax avoidance via related-party transactions based on the arguments that
paying rent to a spouse is not an arms-length transaction, is not necessary and
ordinary, and in some cases the lessee has an equity interest in the property.
If you deduct rental payments made to the spouse for use of his or her
jointly owned property, follow these precautions: (1) have evidence that the
spouse acquired the equity in the property; (2) make sure there is a written
rental agreement and a fair market value rental rate, and (3) deduct the taxes,
interest, and insurance on the rented property on the spouse's Schedule E.
Material Participation
The material participation test is used to determine if a retiree is
receiving self-employment income that may reduce retirement benefits.
If the owner's objective is to avoid self-employment income, there must be
no arrangement that requires material participation and no actual material
participation in.the business. It is further recommended that the owner states
in the written agreement that he/she is not going to materially participate in
the business. Strong evidence of material participation is demonstrated when
the owner "periodically inspects the production activities," "periodically
advises or consults with the other person," "furnishes a substantial portion of
the machines and livestock used in production" or "assumes financial
responsibility for a substantial part of the production expense."
If the owner's objective is to have self-employment income, the intent and
plan for material participation should be included in the rental or lease
agreement, and regular management services or qualified participation must be
provided.
The "substantial services" test is used to determine if and when an indi­
vidual retires and becomes eligible for social security benefits.
•
56
NEW YORK STATE INCOME TAX
New York passed a tax law in 1992 which further delayed the phase-in that
was provided for in the Tax Reform and Reduction Act of 1987. The phase-in that
was intended to be complete by 1991 will now be complete in 1995.
Exemptions and Standard Deductions
The 1992 law holds the 1992 standard deductions at 1989-91 levels and
gradually increases them between 1993 and 1995 to the levels that NYTRRA 1987
intended for 1991. Tune in again next year for news of additional delays.
Year
1995
and
after
---.------- Standard Deduction ($) --_.------­
Tax Status:
Joint
Head of household
Single
Married filing separately
Dependent filers
$9,500
7,000
6,000
4,750
2,800
$9,500
7,000
6,000
4,750
2,800
$10,800
8,150
6,600
5,400
2,800
$12,350
10,000
7,400
6,175
2,900
$13,000
10,500
7,500
6,500
3,000
--------------- Exemption ($) ---------------­
1,000
1,000
1,000
1,000
1,000
Married persons filing separately each will receive one-half of the joint
standard deduction. The standard deduction of a dependent individual whose fed­
eral exemption is zero is $2,800 in 1991-93, $2,900 in 1994, and $3,000 in 1995
and later. An exemption is not counted for either the filer or the spouse.
Estimated Tax Rules for 1992
New York residents with New York source income are required to make payments
of estimated tax if they expect to owe, after withholding and credits, at least
$100 of New York tax and withholding and credits are expected to be less than
the smaller of (a) 90 percent of the tax for the year, or (b) 100 percent of the
tax on the prior year's return (provided a return was filed and the taxable year
consisted of 12 months).
For tax years beginning after 1991 and before 1997, a taxpayer may not use
the preceding year's tax part of the rule if modified NYAGI exceeds NYAGI for
the preceding year by more than $40,000 ($20,000 if married and filing separate
return), NYAGI for the current year exceeds $75,000 ($37,500 if married with
separate return), the taxpayer has made an estimated tax payment in any of the
preceding three years, or was assessed a penalty for failure to pay estimated
tax for such years and the amount computed based on 90 percent of the current
year's tax is greater than the estimated payments based on 100 percent of the
tax shown on the prior year's return.
Modified AGI for the current year is AGI less any gain from the sale or
exchange of a principal residence or from an involuntary conversion and some
other items. See publication 150 (5/92) for additional information and the
complete definition of modified NYAGI.
57
Farmers and fishermen (fisherpersons) may use the preceding year's tax as a
method of determining the required annual payment without regard to the above
limitation.
Itemized Deductions
For taxpayers who filed joint federal returns but are required to file sepa­
rate New York returns, itemized deductions will be divided between them as if
their federal taxable incomes had been determined separately. Taxpayers who do
not itemize deductions on their federal returns may not itemize on their NYS
returns.
Itemized deductions of higher-income taxpayers are subject to limitations.
Itemized deductions are reduced by the sum of two percentages. The first
percentage becomes effective at NYAGI levels which depend on the taxpayer's
filing status, and the second becomes effective at NYAGI levels above $475,000.
1. The first percentage is 25 percent of a ratio which depends on the
taxpayer's filing status:
Numerator - Lessor of
$50,000 or the excess
of NYAGI over:
Denominator
Married filing jointly
$200,000
$50,000
Single and married
filing separately
$100,000
$50,000
Head of household
$150,000
$50,000
Filing Status
Example of first percentage (married, joint return):
NYAGI - $225,000
$25,000 + $50,000 - .5; .5 x25% - 12.5%
This taxpayer would not be subject to the second percentage because AGI is
less than $475,000.
2. The second percentage is 25 percent of a ratio, the numerator of which is
the lesser of $50,000 or the excess of NYAGI over $475,000 and the
denominator of which is $50,000.
Example of second percentage:
NYAGI - $550,000
$550,000 - $475,000 - $75,000; $50,000 is lesser.
$50,000 + $50,000 - 1.0; 1.0 x 25% - 25%
This taxpayer would also be subject to the full 25 percent from the first
calculation so the total reduction in itemized deductions would be 50
percent.
Supplemental Tax for Taxpayers with NYAGI Exceeding S100.000
Beginning in 1991, taxpayers with New York adjusted gross incomes exceeding
$100,000 pay a special tax computed with a worksheet. The' purpose of this tax
is to remove the benefits of the lower tax brackets (the "tax table benefit").
Over the NYAGI range of $100,000 to $150,000, the benefits of the rates below
the top rate will be completely phased out.
Example: Pat and Pete Proficient have a NY taxable income of $105,000 and a.
NYAGI of $120,000. Tax on $105,000 from the tax table is $7,551, but at the top
-
58
rate of 7.875 percent is $8,268.75. The $20,000 that exceeds the NYAGI level of
$100,000 is 40 percent of $50,000. The difference between $8,268.75 and $7,551
is $717.75; 40 percent of this is $287, which is added to the tax computed from
the table to make the total tax $7,838.
There are three separate rate tables for (1) married filing jointly and
qualifying widow(er)s, (2) single, married filing separately, and estates and
trusts and (3) heads of households. Filing status will conform to federal sta­
tus except that when the New York resident status of spouses differs, separate
returns must be filed.
The 1992 law delayed the implementation of the 1990 rates that were in the
1987 law until 1995. Rates for that year are:
New York State Tax Rates, 1995
New York Taxable Income
Filing Status
Rate
Married filing jointly
& surviving spouse
Not over $27,000
Over $27,000
5.5%
7.0
Single, married filing separately,
estates & trusts
Not over $12,500
Over $12,500
5.5
7.0
Head of household
Not over $19,500
Over $19,500
5.5
7.0
There is a gradual phase-in. The rate schedules for 1992 follow. These are the
same schedules that were in effect for 1990 and 1991. The 1993 and 1994 rates
in the 1991 law were modified by the 1992 law but are not shown here.
Married Filing Jointly and Qualifying Widow(er)
If the 1992 New York taxable income is:
Over
$
0
11 ,000
16,000
22,000
26,000
Not Over
$11,000
16,000
22,000
26,000
Tax
$
440
690
1,050
1,330
plus
plus
plus
plus
4% of the excess over
5%
"
"
6%
"
7% "
"
"
7.875%
"
11
11
11
11
11
11
11
11
$
0
11,000
16,000
22,000
26,000
Single. Married Filing Separately and Estates and Trusts
If the 1992 New York taxable income is:
.
Over
.
$
0
5,500
8,000
11 ,000
13,000
Not Over
$ 5,500
8,000
11,000
13 ,000
I
I
I
Tax
$220
345
525
665
plus
plus
plus
plus
0
4% of the excess over $
5%
."
5,500
6% ..
8,000
"
"
"
7%
11,000
"
"
13 ,000
7.875%
"
"
11
11
.
11
11
11
59
Head of Household
If the 1992 New York taxable income is:
Over
$
0
7,500
11,000
15,000
17,000
Not Over
$ 7,500
11,000
15,000
17,000
Tax
$
300
475
715
855
plus
plus
plus
plus
4% of the excess over $
0
5%"
"
7,500
"
"
11,000
6%"
"
"
"
15,000
7%"
"
"
"
17,000
7.875% "
"
"
Household Credit
The 1992 law provided that the full amount of credit will be allowed for
taxable years beginning in 1992 and 1993, and 50 percent of the credit will be
allowed for 1994. For taxable years beginning after 1995, the credit is
eliminated.
Single taxpayers with household gross income up to $28,000 and all other
taxpayers with income up to $32,000 qualify for a household credit providing
they cannot be claimed as a dependent on another taxpayer's return. Household
gross income is federal adjusted gross income (total for both spouses if sepa­
rate returns are filed).
In 1992, the amount of household credit for single taxpayers ranges from $75
(less than $5,000 of HGI) to $20 for taxpayers with $25,000 to $28,000 of HGI.
A separate schedule allows more credit for married taxpayers, heads of house­
hold, and surviving spouses, plus additional credit ($5 to $15) for additional
exemptions. The maximum credit for a married couple with less than $5,000 of
HGI is $90 plus $15 for each personal exemption less one.
Real Property Tax Credit
The tax credit computations and limits are the same for 1992 as for 1991.
Few farm or nonfarm real estate owners will qualify. Owners of real property
valued in excess of $85,000 are excluded. Here are other rules and limitations:
1. The household gross income limit is $18,000.
2. The maximum adjusted rent is now an average of $450 a month, but the
taxpayer must occupy the same residence for six months or more to claim rent
paid for credit. Credit for renters is computed the same as for owners.
3. Real property tax credit is the lesser of the maximum credit or 50 percent
of excess real property taxes. Taxpayers age 65 and older who elect to
include the exempt amount of real property taxes will receive no more than
25 percent of excess real property taxes. Excess real property taxes are
computed by multiplying household gross income times the applicable percent­
age and deducting the answer from real property taxes.
•
60
Partial Table for Computing Real Property!ax Credit, 1991
Maximum Credit
Under 65
65- & Over
Applicable Rate
Household Gross Income
$0 - $ 1,000
0.035
$75
$375
5,001
6,000
0.045
65
290
10,001 -
11,000
0.055
55
205
15,001
16,000
0.065
45
120
17,001 -
18,000
0.065
41
86
Spousal IRAs Allowed
A spousal IRA deduction claimed on a joint federal return is allowed on the
New York return. If separate returns are filed, each spouse's deduction must
equal the amount contributed to his or her own account.
Child and Dependent Care Credit
Twenty percent of the federal child care credit may be used to offset New
York State personal tax liability. The amount of credit used may not exceed the
tax liability for the year. The credit is not allowed against the minimum tax.
Other Credits
Other New York personal income tax credits include resident credit for in­
come taxes paid to other states, accumulation distribution credit, investment
credit, mortgage recording tax credit, -and economic development zone credit.
Review of New York State Farm Business Tax Problems and Opportunities
ACRS and New York State Depreciation
1. New York State recognizes (accepts) ~CRS or MACRS depreciation on assets
placed in service on or after January 1, 1985.
2. The adjustment problems caused by NYS nonrecognition of ACRS .depreciation
during 1982 through 1984 are just about history. There may be some assets
out there that still have a higher NYS basis. The law allows a modification
to federal AGI in the year of disposition on an asset where NYS depreciation
has been different than federal. This enables a taxpayer claiming less NYS
depreciation than allowed under ACRS to decrease fede~al AGI for state
purposes in the year of disposition. If NYS depreciation were greater than
federal, the modification would be an increase in AGI.
New York State Filing Requirements for Certain Small Partnerships
New York law does not contain a provision similar to the federal rule that
allows certain small partnerships with 10 or fewer partners to not file a part­
nership return. Therefore, all partnerships having a New York resident partner
or having any income derived from New York sources must file a partnership re­
turn. The penalty for not filing is $50 times the number of partners who were
subject to the New York personal income tax for the year times the number of
months (not to exceed five) that the failure to file continues.
61
Penalties will be waived for partnerships that failed to timely or com­
pletely file New York returns for prior years due to reliance on the federal
ruling. Penalties will be waived only once.
Partnerships that filed late or incomplete returns for prior years and were
billed for penalties should return a copy of the tax notice with a statement ex­
plaining that the partnership qualified for the federal automatic reasonable
cause provision and that the partnership relied on the provision in not filing
New York returns. Partnerships that have not filed for prior years should do so
immediately. When the partnership receives a bill for the penalty due, it
should follow the procedure outlined above. If requested by the Department, any
partnership that requests a waiver of penalty must be able to substantiate that
all partners have fully reported their shares of the income, deductions, and
credits from the partnership on their timely filed personal income tax returns.
Corporate Tax Surcharge
A "temporary" corporate surcharge applies to the franchise tax, after
credits (but not to New York S corporations except as noted in the next
section), starting with tax periods ending after June 30, 1990. The surcharge
is 15 percent for tax years ending on or before June 30, 1993 and 10 percent
between that date and June 30, 1994.
Franchise Tax on New York S Corporations
For tax years beginning in 1990 and later, S corporations become subject to
tax under a rather complicated set of rules. The tax applies when the corporate
franchise tax rate plus the surcharge exceeds the highest personal tax rate for
the corresponding tax year. S corporations with "entire net income" less than
$200,000 are taxed at a lower rate. "Entire net income" is calculated as it
would be if the S corporation were a C corpqration. Anyone involved in tax
returns for New York S corporations needs to study the rules.
New York State Investment Credit is Four Percent
The credit for individuals is 4 percent on qualified tangible personal
property acquired, constructed, reconstructed or erected on or after January I,
1987. For corporations, the rate for years beginning in 1990 was 5 percent on
the first $425,000,000 of investment credit base and 4 percent on any excess.
In 1991 and later, the 5 percent credit applies only to the first $350 million.
MACRS property placed in service after December 31, 1986 qualifies for NYIC.
This means that farm property in the ACRS or MACRS 3-year class should qualify.
There is no reduction in the amount of credit allowed for 3-year property, and
if kept in use for three years it will earn 4 percent NYIC. The fact that
pickups are 5-year MACRS property will not change the disallowance of NYIC for
farmers.
All ACRS and MACRS property that qualifies for NYIC and is placed in a 5­
year or longer life class earns full credit after 5 years even if a longer
straight line option is elected .. The same is true of 7, 10, 15, and 20-year
MACRS property. Non-ACRS/MACRS properties that qualify for NYIC must still be
held 12 years.
Excess or unused credit may be carried over to future tax years but the
carryforward period is limited to seven years. There is no provision for
carryback of NYIC. Unused NYIC claimed by a new business is refundable' for tax
years beginning on or after January I, 1982. The election to claim a refund of
•
..
62
unused credit can be made only once in one of the first four years. A business
is new during its first four years in New York State. Only proprietorships and
partnerships qualify. This refundable credit is not an additional credit for
new businesses. A business that is substantially similar in operation and
ownership to another business that has operated in the state will not qualify.
If property on which the NYIC was taken is disposed of or ~emoved from
qualified use before its useful life or specified holding period ends, the dif­
ference between the credit taken and the credit allowed for actual use must be
added to the taxpayer's tax liability in the year of disposition. However,
there is no recapture once the property has been in qualified use for 12
consecutive years.
Use IT-2l2 to claim New York investment credit, retail enterprise credit and
to report early disposition of qualified property.
Employment incentive tax credit is available to regular corporations that
qualify for NYIC and increase employees at least 1 percent during the year. The
credit is 1.5 percent of the investment credit base if the employment increases
less than 2 percent, 2 percent if the increase is between 2 and 3 percent, and
2.5 percent if the increase is 3 percent or more for each of the two years fol­
lowing the taxable year in which NYIC was allowed. The additional credit is
available to newly formed as well as continuing corporations. The credit may
not be used to reduce the franchise tax below the flat-fee minimums ($325. $425.
$800 and $1,500 depending on the size of the corporation).
New York State Minimum Tax
Federal items of tax preference after New York modifications and deductions
are subject to the New York State minimum tax rate of 6 percent. The primary
deduction is $5,000 ($2,500 for a married taxpayer filing separately). A farmer
who has over $5,000 of preference items must complete Form IT-220 but may not be
subject to minimum tax. New York personal income tax (less credits) and
carryover of net operating losses are used to reduce minimum taxable income.
NYIC cannot be used to reduce the minimum income tax.
Payment of New York State Income Taxes Withheld and Informational Returns
For 1992 and later, filers with less than $700 in quarterly withholding
liability are required to deposit the withholdings for each quarter-by the end
of the month following the end of the quarter, except for the last quarter,
which is due February 28. In general, filers with $700 or more in quarterly
withholding liability are required to make the deposit within three business
days following the payroll date on which the $700 total was attained. There are
exceptions and additional rules. See WI-lOO, New York State Withholding Tax
Guide, for the complete rules.
New York State law is essentially identical to the federal law requlrlng in­
formational returns on payments of $600 or more to New York taxpayers.
l
. .­
OTHER AGRICULTURAL ECONOMICS EXTENSION PUBLICATIONS
No. 92-12
Dairy Farm Business Summary
western Plateau Region 1991
George L. Casler
Andrew N. Dufresne
Joan S. Petzen
Michael L. Stratton
Linda D. Putnam
No. 92-13
Dairy Farm Business Summary
Eastern Plateau Region 1991
Robert A. Milligan
Linda D. Putnam
Carl Crispell
Gerald A. LeClar
A. Edward Staehr
No. 92-14
Dairy Farm Business Summary
Northern Hudson Region 1991
Stuart F. smith
Linda D. Putnam
Cathy S. Wickswat
W. Christopher
Skellie
Thomas J. Gallagher
No. 92-15
Bibliography of Horticultural
Product Marketing and Related
Topics
Enrique Figueroa
No. 92-16
New York State Fresh Market Apple
Export Survey: Results from
Packers/Shippers and Growers
Peter Fredericks
Enrique Figueroa
No. 92-17
Dairy Farm Business Summary
Eastern New York Renter Summary
1991
Stuart F. Smith
Linda D. Putnam
No. 92-18
State of New York/New Jersey Food
Industry
Wholesale Club Stores:
The Emerging Challenge
Edward McLaughlin
Gerard Hawkes
Debra Perosio
No. 92-19
Where to find Information on the
Food Industry: A Researcher's
Guide
Edward W. McLaughlin
Sandy Freiberg
•